Deck 17: Regulation of Securities, Corporate Governance, and Financial Markets

Question 1

Preferred stock always has voting rights.

Answer 1

False
Explanation: Preferred stock may or may not have voting rights, depending on the purchase agreement.

Question 2

The primary market consists of securities sales in public markets, while the secondary market consists of security sales in private placements.

Answer 2

False
Explanation: Both sales in public markets and in private placements occur in the primary market.

Question 3

State security laws are generally referred to as ________ laws.

Answer 3

blue-sky

Question 4

Bonds are debt instruments secured by company assets.

Question 5

An ________ is a professional in the securities market that agrees to facilitate the sale of stock to the public for a fee.

Question 6

An ________ investor is one who has experience, business savvy, and knowledge of the market to the extent that the law imputes a certain cognizance of investment risk and the ability to protect his or her own interests.

Question 7

The SEC has the power to initiate criminal actions against individuals or companies that violate security laws.

Question 8

Evidence of specific intent to deceive, manipulate, or defraud is called _______.

Question 9

Assumption of risk by the investor is a defense available for allegations of 33 Act violations.

Question 10

Preferred stock is the most frequently used form of equity instrument.

Question 11

The SEC has the power to suspend or revoke the licenses of brokers that violate securities laws.

Question 12

A person who receives nonpublic confidential information regarding a company and uses that information to realize a profit is called a _______.

Question 13

Holders of equity securities have no specific right or guarantee of a return on their investment.

Question 14

Public corporation disclosures and filings are made available to the general public.

Question 15

Any officer, director, or shareholder who owns 10 percent or more of a company's stock is considered an _______.

Question 16

The SEC's computer database, which maintains the national clearinghouse for public corporation disclosures, is known as _______.

Question 17

On a bond, the face amount is also called the _______.

Question 18

Under Sarbanes-Oxley, requiring the payback of corporate bonuses that were awarded and later found to be based on false disclosures is called a ________ provision.

Question 19

Only Congress may enact securities regulations, and only the courts may interpret securities statutes.

Question 20

Payments made to common stockholders based on the profitability of the company are called _______.

Question 21

The foundation and underlying principle of all securities regulation is disclosure.

Question 22

Debentures are unsecured equity instruments that are issued by a corporation.

Question 23

Security sales to venture capitalists often do not require full registration.

Question 24

Federal securities laws can, depending on the language and circumstances, classify a business plan as a form of securities offering.

Question 25

Prior to the passing of the Sarbanes-Oxley Act, the auditing in the accounting profession was self-regulating.

Question 26

A promissory note securing a home mortgage is a security instrument.

Question 27

Securities may not be sold or marketed to the public until the SEC has completed its review phase and the registration becomes effective.

Question 28

Rule 10(b)(5) of the 34 Act is aggressively used by the SEC in terms of insider-trading enforcement.

Question 29

Violation of Section 16, a finding of short-swing liability, does not require evidence of the use of insider information and is deemed a strict liability provision.

Question 30

If a company files bankruptcy, preferred stockholders have priority over common stockholders and will be paid from the bankruptcy estate first if payments are to be made.

Question 31

The sales of securities in the secondary market does not raise capital for the business whose stock is sold.

Question 32

Issuing securities to the public markets for the first time is called an initial public offering.

Question 33

When a corporation issues securities under a nonpublic offering or safe-harbor exemption from SEC regulations, it is free of the burden of supplying any disclosures to the investor due to the investor's experience and knowledge of the process.

Question 34

MFK Corp. wants to raise capital and is considering an offer of bonds and debentures. It is not sure of a particular disclosure requirement, so MFK poses its question to the SEC and request an interpretation letter. If the SEC issues an interpretive letter addressing MFK's question and MFK follows the statements contained in the letter, MFK will not be able to be penalized by the SEC should the advice be incorrect.

Question 35

A security can exist in the absence of a formal certificate evidencing the investment and also in the absence of an interest taken in the tangible assets of the company being invested in.

Question 36

Most common stock enjoys voting rights; however, common stock may be sold without voting rights.

Question 37

Blue-sky laws are federal security laws that preempt state security laws.

Question 38

Investors holding debt instruments are primarily interested in a fixed rate of return on their investment regardless of the profitability of the company.

Question 39

Annuities issued by insurance companies are exempt from full SEC registration requirements.

Question 40

The original Howey test required that the investor have no involvement with the generation of profits; however, modern courts have permitted a limited passive involvement on the part of the investor.

Question 41

The most commonly used debt instrument is:

A) a debenture.
B) a bond.
C) common stock.
D) a promissory note.

Question 42

Penalties for violations of the 33 Act may include each of the following except:

A) civil penalties and fines.
B) revocation of the corporate charter for egregious cases.
C) criminal prosecution and incarceration.
D) revocation of the investment by the investor.

Question 43

The SEC is an independent agency that:

A) is not under the direct control of the president.
B) is under the direct control of the president.
C) is under the direct control of the Department of Justice.
D) is under the direct control of the U.S. Treasury Department.

Question 44

Rule 16 of the 34 Act defines an insider as an officer, director, or shareholder who owns ________ or more of the company's total stock.

A) 5 percent
B) 10 percent
C) 15 percent
D) 20 percent

Question 45

Sunshine Corporation has just filed bankruptcy. Among the investors, who will be paid first?

A) All investors are treated equally, so they all get paid their fair shares simultaneously.
B) Bondholders are paid first.
C) Common stockholders are paid first.
D) Preferred stockholders are paid first.

Question 46

In 2002, Martha Stewart, the media mogul and CEO of Martha Stewart Living, was prosecuted for insider trading regarding her sale of ImClone stock. Her stockbroker had informed her that Samuel Waksal, the CEO and chairman of ImClone, was selling substantial amounts of his stock in the company, so she then sold her ImClone holdings. What was Martha's fate?

A) Since she "saved" only $45,000 by selling her stock, her dealings were deemed too insignificant and the matter was not pursued.
B) She was found guilty of insider trading as a tippee and went to jail.
C) She claimed that she was merely acting on her broker's advice and didn't know the information provided was material and nonpublic, so she didn't qualify as a tippee.
D) She was found guilty of obstructing justice in a securities investigation and went to jail.

Question 47

The SEC is composed of ________ commissioners.

A) three
B) five
C) seven
D) nine

Question 48

Kate is an underwriter who acted as a third party conducting a sale of securities between Fox Co. and an investor. Subsequent to the sale it is discovered that the disclosures made by Fox Co. were fraudulent. The investor has sued both Fox Co. and Kate. What is Kate's best defense to avoid liability?

A) proving that she actually did not profit from the transaction
B) proving that the fraud was so sophisticated that even if she had investigated the preregistration and registration documentation, she probably wouldn't have discovered the fraud anyway
C) proving that the issuing company had a long history of truthful disclosures and had never been suspected or investigated for fraud, so she was able to rely on their representations
D) proving that she exercised due diligence in examining the preregistration and registration documentation and did not discover the fraud

Question 49

The Financial Stability Oversight Board created by the Restoring American Financial Stability Act of 2010 has the power to:

A) break up companies deemed to pose a threat to the nation's financial markets even if the company is not insolvent.
B) compel the SEC to assume an oversight position over institutions that pose a global risk to financial markets.
C) approve or disapprove executive compensation packages, including bonuses, regarding companies deemed "too big to fail."
D) criminally prosecute officers and board members of companies that are found to have committed fraud and that have harmed the public or the national economy.

Question 50

The Securities Act of 1934 focuses on the:

A) primary market.
B) secondary market.
C) preferred market.
D) common market.

Question 51

Micro bonds appeal to small business ventures that wish to take advantage of bond financing in the ________ range.

A) $50,000 to $100,000
B) $100,000 to $500,000
C) $500,000 to $1,000,000
D) $1,000,000 to $5,000,000

Question 52

The corporate counsel's opinion verifying the business venture's adherence to corporate formalities and a letter of compliance and opinion from the corporation's accounting firm are contained in the:

A) prospectus.
B) letters of intent.
C) supplemental information.
D) comfort letters.

Question 53

Which of the following is not a required preregistration document?

A) the prospectus
B) letters of intent
C) an underwriting agreement
D) comfort letters

Question 54

Which of the following is an equity instrument?

A) debenture
B) bond
C) common stock
D) promissory note

Question 55

In SEC v. Switzer et al., Switzer overheard a conversation while in a public place and, based on the information heard during the conversation, formed a group to purchase stock in a corporation that subsequently showed a substantial profit. When the SEC brought charges of insider trading against Switzer, the court said:

A) since Switzer was not a direct participant in the conversation, he could not be prosecuted as a tippee.
B) Switzer was not a tippee because he did not know that the information overheard was material and nonpublic.
C) the insider that Switzer overheard was guilty of a breach of his fiduciary duty to his company because he spoke about the company in a public place.
D) the insider that Switzer overheard was guilty of a breach of his fiduciary duty to his company and was guilty of insider trading because he was telling his wife material and nonpublic information.

Question 56

The purchase and sale of issued securities between investors is called the:

A) primary market.
B) secondary market.
C) preferred market.
D) common market.

Question 57

The Sarbanes-Oxley Act imposed stricter regulations on how corporations do business through regulations in each of the following areas except:

A) tax compliance.
B) financial reporting.
C) corporate governance.
D) auditing.

Question 58

Security transactions involving the original issuance and reissuance of securities by a business to raise capital are called the:

A) primary market.
B) secondary market.
C) preferred market.
D) common market.

Question 59

Whether a dividend is paid depends on:

A) the officers agreeing to pay the dividend.
B) the board of directors agreeing to pay the dividend.
C) the shareholders voting to award themselves the dividend.
D) the applicable state law, which mandates whether dividends must be paid.

Question 60

Wayne is the president and CEO of a corporation. He owns 25 percent or the company's total stock and has been selling large chunks of his holdings over the past three months. If the SEC investigates him for short-swing profits, it would do so under:

A) Regulation D of the 33 Act.
B) Rule 10(b)(5) of the 34 Act.
C) Section 16 of the 34 Act.
D) the Private Securities Litigation Reform Act of 1995.

Question 61

Under the emergency escrow provisions created by the Sarbanes-Oxley Act:

A) the SEC may require corporate payouts into a government-controlled emergency escrow fund after the SEC investigation has uncovered wrongdoing by the corporation.
B) the SEC may require corporate payouts into a government-controlled emergency escrow fund during its investigation and before the SEC has uncovered wrongdoing by the corporation.
C) the PCAOB may require corporate payouts into a government-controlled emergency escrow fund after the PCAOB investigation has uncovered wrongdoing by the corporation.
D) the PCAOB may require corporate payouts into a government-controlled emergency escrow fund during its investigation and before the PCAOB has uncovered wrongdoing by the corporation.

Question 62

Which of the following is not a component in the definition of a security?

A) an investment
B) an expectation of profit
C) tangible collateral to secure the instrument
D) efforts of a third party to create expected profit

Question 63

Gina is the executive secretary to the CEO of a large public corporation. One day her boss takes her into a back room containing numerous cardboard file boxes and three shredding machines, and he orders her to shred every document and file in the room. He then says, "We're under investigation by the SEC, and if they get their hands on anything in this room, we're ruined." She asks what is going on and is told that the company has been perpetrating frauds for years and needs to destroy all the evidence.

A) Since Sarbanes-Oxley does not have a whistle-blower provision, Gina has no recourse if she wants to keep her job.
B) Since Gina didn't actually participate in the frauds and since she is only following orders, she will have no liability.
C) Since the investigation is ongoing and no charges have been brought, shredding the documents is not a punishable offense yet.
D) Gina could be imprisoned for up to 20 years if she shreds the documents.

Question 64

Eve is a promoter and has approached Adam with an investment opportunity. Eve anticipates a generous profit and informs Adam that he too can realize a generous profit. This opportunity is not being offered to others. Assuming all other requirements to classify this as a security are in evidence, the commonality of this transaction would be described as a:

A) horizontal commonality.
B) parallel commonality.
C) vertical commonality.
D) common commonality.

Question 65

Fred is a corporate insider and has made some very large profits through the buying and selling of his corporation's stock during the previous six months. These profits would be called:

A) short-term profits.
B) short-range profits.
C) short-spell profits.
D) short-swing profits.

Question 66

The Restoring American Financial Stability Act of 2010 established the Consumer Financial Protection Bureau. What is the authority of this agency?

Question 67

Under TARP provisions:

A) shareholders' approval on compensation packages recommended by the company's compensation committee is binding.
B) if the board disregards the shareholders' vote on a recommended compensation package, the board is automatically in breach of its fiduciary duties to the company and the company's owners.
C) the shareholders have no right to vote on compensation, so their approval or disapproval of the compensation committee's recommendation is not considered.
D) shareholders have a nonbinding vote on any compensation plan recommended by the board of directors.

Question 68

Joan is the CFO of Para Corp. and is a year from retirement. In order to guarantee herself a very substantial bonus and to boost her retirement package, she knowingly certifies false financial reports that make the company appear to be much more profitable than it really is. She further takes steps to ensure that the financial report does not get reviewed through internal controls maintained by Para Corp. Under provisions of the Sarbanes-Oxley Act, what are the possible penalties that may be imposed when her actions are discovered?

Question 69

One form of private placement exemption involves sales of securities:

A) in limited dollar amounts to nonaccredited investors.
B) only to employees, officers, and board members of the issuing corporation.
C) to accredited investors.
D) to other corporations, with no sales to individuals permitted.

Question 70

With regard to financial reporting and corporate governance, what is now required of public companies under the Sarbanes-Oxley Act?

Question 71

The Securities Act of 1933 focuses on the:

A) primary market.
B) secondary market.
C) preferred market.
D) common market.

Question 72

Brent has opened a fruit and vegetable business named Brent's Country Stand near an affluent suburban neighborhood. After six months Brent wishes to raise capital for expansion, so he offers a number of his customers the following deal: If the individual gives Brent $10,000, Brent will provide a promissory note, payable in five years with full repayment of the principal and a 10 percent interest rate of return. Brent's Country Stand is the maker of the notes, and about 10 customers have purchased these notes. Do these promissory notes qualify as securities? Why or why not?

Question 73

In what two ways do federal securities statutes define a security?

Question 74

The SEC maintains ________ regional offices, throughout the United States, where much of its day-to-day work is done.

A) 8
B) 11
C) 13
D) 21

Question 75

Donald is the president and CEO of Formerly Fat Inc., a health and diet company that promotes weight loss through its "revolutionary" feast and famine diet. The diet calls for eating anything you want on Tuesdays and Thursdays, with fasting on Mondays, Wednesdays, and Fridays. On weekends, food is limited to one big lunch each day. Formerly Fat has a celebrity spokesperson who claims she and all her Hollywood friends swear by this diet, and the company has infomercials running on television constantly. On a Friday afternoon, Donald is called by a reporter, who asks if he's concerned that the New England Journal of Medicine, one of the most respected and prestigious medical journals in the country, is about to publish an article on Tuesday documenting that numerous practitioners of this diet suffer from serious medical problems and that three deaths have occurred relating to the diet. The article's authors will be calling for an investigation and eventual ban on advertising and promotion of the diet. Donald laughs and claims the article will be challenged and shown to be inaccurate. As soon as he hangs up, he calls his wife, who has the company stock in her name for liability reasons, and then his brother and says to each, "I just got word that the company is in trouble, and we will have problems soon. Sell your stock immediately." On Monday morning, his wife and brother sell all of their holdings. On Tuesday the article is published, and by Wednesday the stock value is down 40 percent. Discuss this situation.

Question 76

Once a corporation has submitted a registration statement to the SEC, what responses may the SEC make and what is the required timing of these responses?

Question 77

The "safe-harbor" exemption from SEC regulations involves:

A) nonpublic offers to a limited number of sophisticated investors who already have business relationships with the issuer.
B) nonpublic offers to a limited number of sophisticated investors who privately negotiate their securities purchases.
C) offerings with specified dollar limitations and/or limitations on the number of accredited investors.
D) offerings with specified dollar limitations and/or limitations on the number of nonaccredited investors.

Question 78

In SEC v. W. J. Howey Co., the Supreme Court decision led to what is commonly called the Howey test to determine whether something qualified as a security. Identify and explain the four components of this test.

Question 79

Frank is the president and CEO of a publicly held corporation and is quoted in the paper as saying that the company is solid and has a bright future. He mentions a number of projects and plans that he anticipates will be successful in both the short term and long term, thus benefiting the company. Betty Sue reads this article and calls a broker, directing him to buy shares in Frank's company. After two years the stock is below the price she paid for it, and she brings suit, claiming that Frank committed a fraud when he stated that the company was solid and would be very successful in the future. What must be proved by each side, and what is the likely outcome of this suit?

Question 80

Imagine that the SEC had investigated ENRON prior to its collapse and had found extremely serious violations of various securities statutes and regulations. What two things might the SEC have done in the exercise of its delegated executive powers and administrative enforcement powers?