1
Q
Chapter 3: Section 3 Fed Rules
Technical Insider Definition
Under ‘34 Act
A
- Officer
- Director
- 10% Shareholder of Issuers Equity Securities
2
Q
Chapter 3: Section 3 Fed Rules
Courts Definition of an Insider
A
- Any person who has received material non-public information that can be expected to influence the price of a company’s stock.
3
Q
Chapter 3: Section 3 Fed Rules
When does an insider trading violation occur?
A
- If the recipient (“tippee”) uses the information to trade for profit.
- either trading that security or the equivalent security or options of that issuer.
- The tipper and tippee are liable under the act.
4
Q
Chapter 3: Section 3 Fed Rules
Whe is inside information public?
A
- once information is made public the insider can trade.
- information is considered public when it has been released by the news media.
5
Q
Chapter 3: Section 3 Fed Rules
Insider Trading and Fraud Enforcement Act of 1988 requires BDs to?
A
- establish, maintain, and enforce written policies and procedures designed to prevent the misuse of material, non-public informaiton by any associated person.
6
Q
Chapter 3: Section 3 Fed Rules
Information Barriers
A
all firms set up information barrriers that fully segregate the information flow.
Research - barrier - investment banking / retail sales / trading
Investment Banking - barrier - research / retail sales / trading
7
Q
Chapter 3: Section 3 Fed Rules
Penalty for Insider Trading
A
- civil penalties:
up to 3 times the profit realized or loss avoided treble damages) - criminal penalties
fine up to $5MM and up to 20 years in jail for each violation
8
Q
Chapter 3: Section 3 Fed Rules
Penalty for Controlling Person for Insider Trading
A
- In addition to standard penalties contorlled persons (person is an employee of a BD) have additonal penalties
- Liabilty for the firm is set to $25MM
- SEC will only impose damages on a controlling person only if it can be proven that the person knew or recklessly disregarded the fact that a violation occured and that such a failure substantially contributed to the occurance of the Act.
9
Q
Chapter 3: Section 3 Fed Rules
Informer Bounty
A
- the act allows informants to be paid anywhere from 10% to 30% of the recovered amounts under civil penalties
10
Q
Chapter 3: Section 3 Fed Rules
Insider Trading and Private Parties
A
- Private parties have the right to sue persons who violated the insider trading rules.
- anyone who bought or sold that security during the time period when the inside trades occured can sue the insider for profit gained or loss avoided.
- Statute of limitations is 6 years.
11
Q
Chapter 3: Section 3 Fed Rules
10b5-1
A
- insiders can avoid insider trading violations by setting up a 10b5-1 plan.
- safe harbor rule permits statutory insiders to set up a written plan for trading company securities.
- the plan spedifies future dates with amounts on which securites are to be bought and sold OR specifies the alogrithm to be used for determining the amount and date of future purchases or sales.
- typically the plan is 1 year long, insider cannot deviate from plan
12
Q
Chapter 3: Section 3 Fed Rules
Pre-arranged trading plan cooling off period
A
- the insider cant start trading under the plan for 30-60
13
Q
Chapter 3: Section 3 Fed Rules
Regulation FD
A
- Fair Disclosure
- Designed to address 3 areas:
1. selective disclosure by issuers
2. when a trader is deemed to be an insider
3. family member trades - designed to promote the full and fair disclosure of information by issuers and to clafiry and enhance existing prohibitions against insider trading.
14
Q
Chapter 3: Section 3 Fed Rules
Selective Disclosure By Issuers
A
- the selective disclosure to favored individuals by issuers of material non-public information.
- If an issuer makes material non-public information available to securities market professionals and holders of the issuer’s securities who may trade on it they must make the disclosure public.
15
Q
Chapter 3: Section 3 Fed Rules
To avoid liability if an issuer makes a disclosure of non-public information to securities market professionals they must:
A
- for intentional disclosure: simultaneously disclosing the information by braod distribution to the public
- for non-intentional disclosure: promptly (defined as within 24 hours) disclosing the information either by filign an 8K report wiht the SEC or by a braod distribution of the information to the public
16
Q
Chapter 3: Section 3 Fed Rules
Inside Trade definition
A
- one made on the basis of material non-public information, if the trader was aware of the material, non-public information when the person made the purchase or sale.
17
Q
Chapter 3: Section 3 Fed Rules
Specific Defense Against Insider Trading
A
- the person, before becoming aware of the information, had entered into a binding contract to buy or sell the security
- with respect to the contract, the person demonstrates that the contract specficied the amount, date and price of the trade (or gave a formula for it) and that the person had no influence over the trade
18
Q
Chapter 3: Section 3 Fed Rules
when is a family member an insider
A
a duty of trust or confidence exists when:
- a person agrees to maintain the information in confidence
- two people have a history, pattern or practice of sharing confidences such that the recipient of the information knows or reasonably should know that hte person communicating the material non-public information expects that the receipient will maintain confidentiality
or
- a person receives or obtains material non-public information from certain close family members, spouses, parents, children or siblings
19
Q
Chapter 3: Section 3 Fed Rules
family insider trading
A
- if a family member tradse on inside information an affirmative defense permits the person receiving the information to demonstrate that under the facts and circumstances that a family relationship, no duty of trust or confidence existed.
20
Q
Chapter 3: Section 3 Fed Rules
Section 9 of SEC Act of 1934
Unlawful Practices
A
- effecting transactions in securities where there is beneficial change of ownership (wash trades) wiht the purpose of mileading appearance of activity in that security
- placing an order for a security upon knowledge of orders that have been or will be places at substantially the same price
- effecting a series of transactions in a security to create the impression of falling / rising prices
- offering to buy or sell a security for a customer by giving information to the effect that the price is likely to rise or fall because of market operations of certain persons
- inducing the sale of a scruity by using false / misleading information
- accepting payment for disseminating information that the price of a security is likely to rise or fall
- pegging (stabilizing) the price of a security
21
Q
Chapter 3: Section 3 Fed Rules
timeframes for suits with repsect to section 9 of ‘34 act
A
- 2 years from discovery
- 5 year statute of limitations
22
Q
Chapter 3: Section 3 Fed Rules
section 10 of the ‘34 Act
A
- unlawful for any person to use or employ deceptive or manipulative device in violation of the Act.
Prohibited practices:
1. Rule 10b-1: applies to manipluation of exempt and non-exempt securities
2. Rule 10b -3: unlawful for BDs to use or employ any deceptive or manipulative device
2. Rule 10b-5: known as the catch all fraud rule. unlawful to commit anything that would operate as fraud
23
Q
Chapter 3: Section 3 Fed Rules
Rule 10b-1
A
this section of the act applies to manipulation of both exempt and non-exempt securities
24
Q
Chapter 3: Section 3 Fed Rules
Rule 10b-3
A
unlawful for a BD / muni BD to use or employ any deceptive or manipulative device
25
# Chapter 3: Section 3 Fed Rules
Rule 10b-5
* catch all fraud rule
* illegal for any person to commit undefined actions that woudl operate as a fraud.
26
# Chapter 3: Section 3 Fed Rules
Section 15 of the '34 Act
* places requirements on BDs
* 15a-1 requires BDs that effect trasnactions in securities (other than exempt securities) to be registered.
* allows the SEC to censure, suspend, or revoke the registration of a BD or associated person.
27
# Chapter 3: Section 3 Fed Rules
Investment Advisers Act of 1940
* established to require the regsitration of investment advisers with the SEC and to regulate the actions of investment advsiers at the Federal level.
28
# Chapter 3: Section 3 Fed Rules
Who regulates investment advisors
* split at the federal and state levels
* bigger investment advisors are registered at the federal level and are not required to register in each state
* smaller investment advisors are regulated at the state level and must register in each state in which they do business, they are not requried to register with the SEC
29
# Chapter 3: Section 3 Fed Rules
Investment Adviser
* a person who receives compensation for advising other about securities or about the advisability of investing in securities.
* if a person gives advice about securites and does not charge a fee they are not an investment adviser.
30
# Chapter 3: Section 3 Fed Rules
3 Prong Test
* 3 prong test for investment adviser:
Test 1: Advice is about securities
Test 2: In the business? is it a reguilar thing this person does
Test 3: is the person compensated
ABC test (**a**dvice about securites, in the **B**usiness, Are they **c**ompensated)
31
# Chapter 3: Section 3 Fed Rules
Persons excluded from IA definition
* not required to register with SEC
1. banks or bank holding companies
2. lawyers, accountants, engineers, or teachers
3. BD and their reg reps whose advisory services are solely incidental to the securities business and there is no special compensation for it.
4. publishers of bona fide newspapers, magazines, or financial publications of general and regular circulation
5. any person who advises soley about us gov obligations (us treasuries / agency bonds EXCLUDES Munis)
32
# Chapter 3: Section 3 Fed Rules
Persons exempt from IA registration under federal law
* Interstate exemption: operates in only one state
1. Advisers to insurance companies: only clients are insurance companies
33
# Chapter 3: Section 3 Fed Rules
National Securities Markets Improvement Act of 1996 Requires registration with the SEC only for
* $110 MM in assets under management
(optional if $100-110MM)
* Advisors to investment companies
34
# Chapter 3: Section 3 Fed Rules
Federal Covered advisors
* $110 MM in assets under management
(optional if $100-110MM)
* Advisors to investment companies
* only have to register with the SEC and NOT the state
35
# Chapter 3: Section 3 Fed Rules
Avisory contract rules
* all contracts be in writing
* they cannot provide for compensation to the IA based on capital gains in the account
* cannot provide for a reduction in the advisory fee if the account does not reach a specified performance level
* cannot allow for assingment of the contract to another investment adviser unless the customer consents
* must provide for notifcation to the customers of changes in the composition of the partnership if the adviser is a partnership
36
# Chapter 3: Section 3 Fed Rules
Anti-Fraud Rule
* Investment advisors are prohibited from using mail and other interstate commerce to employ any device, scheme or artifice to defraud a client.
* Applys in all circumstances.
37
# Chapter 3: Section 3 Fed Rules
IA Fiduciary Standard
* IAs must act as a fiduciary for their clients.
* must always act in their best interest and cannot cahrge their clients amounts greater than other advisers offering comparable services
* BDs are held to lower "suitablity" standard
38
# Chapter 3: Section 3 Fed Rules
Principal Transaction
* when an investment advisor buys a security from a customer into the advisers account or sells a security to a customer from an advisors own account
39
# Chapter 3: Section 3 Fed Rules
If an invesment advisor wishes to effect a principal transaction, it must:
* disclose, prior to the completion of the transaction that the adviser is acting in teh capaicity of broker - dealer
and
* obtain consent of the client for the transcation.
40
# Chapter 3: Section 3 Fed Rules
Agency Cross Transaction
* If an IA tells one client to sell a security and helps another client buty the security at the same time
* inherent conflict of interest
41
# Chapter 3: Section 3 Fed Rules
If an IA wishes to effect an agency cross transaction with a customer it must
1. recommend the transaction to only one side of the cross
e.g. one of the customers cannot have been solicited
if they are both solicited the tranaction is probhited.
2. Act in the best possible interest of the cleint to obtain the best possible price.
3. obtain written consent from the customer to effect an agency cross transaction that discloses that the advisor will be acting as a broekr for both the buyer and the seller, and that a commission will be received from both parties, and that a potential conflict of interest exists.
4. send to each clietn at least annually a written disclosure statement idenifying the totoal number of agency cross transactions and total commissions received from such transactions over the past year.
42
# Chapter 3: Section 3 Fed Rules
