In response to a deluge of corporate scandals in the late 1990s and early 2000s, the Sarbanes-Oxley Act of 2002 (Act) implemented sweeping reforms in the area of corporate governance. The Act applies only to public companies that have securities registered with the Securities and Exchange Commission (SEC) under § 12 of the Securities Exchange Act of 1934 (Exchange Act) or are required to file reports under § 13(a) or § 15(d) of the Exchange Act.. The Act covers directors, officers, and shareholders of a public company and professionals who provide services to those companies (for example, accountants and attorneys). The Act specifically prohibits a director or officer from taking “any action to fraudulently influence, coerce, manipulate, or mislead any independent public or certified accountant engaged in the performance of an audit . . . for the purpose of rendering such financial statements materially misleading.” The SEC has the authority to enforce regulations adopted to implement this provision of the Act. The focus is now on fraudulent intent. A director or officer may be held liable without regard to whether the audit report (or financial report) is materially misleading.
Chief executive officers (CEOs) and chief financial officers (CFOs) are barred from profiteering by selling company stock or receiving company bonuses during the time that management is misleading the public and regulators about the company’s “poor health.” If the company fails to comply with Exchange Act filing requirements or has to refile a report due to this type of misconduct, the CEO and CFO must disgorge personal profits. This includes any bonus, incentive-based or equity-based compensation, or profits from the sale of a company security that are received in the 12-month period occurring after the first public issuance or the SEC filing that included the non-complying information, whichever occurred first. If misconduct is involved, CEOs and CFOs may have to disgorge bonus and incentive compensation even if they did not personally commit the misconduct. The SEC has the discretion to determine whether to penalize a CEO or CFO on a case-by-case basis. Misconduct by low-level employees may be one instance in which the SEC could determine that disgorgement would not be appropriate.
If a director or officer is compensated with equity security, the Act prohibits the director or officer from acquiring or transferring that equity security during a “blackout period.” A “blackout” is defined as any period of more than three consecutive business days during which at least 50 percent of the participants in the company’s individual account plans are not allowed to buy, sell, or transfer their stock. The term “blackout” does not include regularly scheduled or timely disclosed suspensions or a suspension that involves administration or consolidation of the plan. Under the Act, a company must give plan participants, beneficiaries, directors, officers, and the SEC notice of any blackout period at least 30 days before the period begins. The company can recover any profits made by a director or officer who violates this provision. If the company does not try to recover those profits within 60 days of a shareholder request, the shareholder can file suit on the company’s behalf to recover those profits. There is a two-year statute of limitations on this type of claim, which runs from the date the director or officer acquired the profit.
Directors and officers (and shareholders with 10 or more percent of the company’s stock) are required to file reports evidencing any change of ownership of company securities in “real time,” i.e., within 2 business days of the ownership change. A director or officer may no longer defer filing of a change of ownership report.
The Securities Act of 1933, enacted in response to the stock market crash of 1929, has been referred to as the “truth in securities” law. The Securities Act generally requires that companies selling their stock to the public must provide investors with full disclosure of material facts. Before offering their stock to the public, companies must file a registration statement with the Securities and Exchange Commission. The registration statement must include:
- A description of the property and business of the company;
- A description of the security being offered by the company;
- Disclosure concerning the company’s management; and
- Company financial statements certified by independent auditors.
The registration statements are examined by Commission staff for compliance with Commission regulations and are made public. While the Commission does not provide an evaluation of the stock being offered by the company, it does declare the registration statement effective if there has been compliance with Commission disclosure rules.
Various categories of stock offerings by companies are exempt from requirements of the Securities Act. Such exemptions include:
- Private offerings to a limited number of buyers;
- Offerings of limited size;
- Intrastate offerings; and
- Securities of federal, state, or local governments.
However, if the transaction involves a security that is being offered or sold and no exemption from registration is available, then that security cannot be offered or sold before a registration statement becomes effective. A broad view is given to the definition of “security” and even such items as time shares in a condominium have been considered securities. Any transaction which includes investment of money in a common enterprise designed to achieve profits through the efforts of others may be considered a security.
Willful violation of the Securities Act or of Securities and Exchange Commission regulations issued pursuant to the Securities Act can result in a prison term of up to five years and a fine. Such penalties have been imposed for the unlawful sale of unregistered securities and for the sale of securities through fraud. The Securities Act also provides purchasers with civil remedies for materially false or misleading registration statements or sales of securities without meeting registration or prospectus delivery requirements.
Municipal bonds and other securities offerings by governmental entities generally are exempt from federal securities law registration requirements. However, information about such offerings is available from sources other than the U.S. Securities and Exchange Commission.
Municipal bond “official statements” or offering documents are filed by underwriters of the bonds with the Municipal Securities Information Library of the Municipal Securities Rulemaking Board and with four private entities known as Nationally Recognized Municipal Securities Information Repositories or NRMSIRs. The NRMSIRs also collect information concerning annual financial data and significant events such as defaults concerning municipal securities. Three states — Texas, Michigan, and Ohio — maintain their own information depositories containing information about municipal securities issued in those states.
The Municipal Securities Rulemaking Board was created through the Securities Acts Amendments of 1975. The Board was established to set rules governing the conduct of those involved in the trading of municipal securities in lieu of governing the conduct of municipalities and other governmental entities in issuing bonds. The Board is composed of equal numbers of public members, bank dealer representatives, and securities dealer representatives. Although the Board is considered a self-regulating organization and its activities are subject to oversight from the Securities and Exchange Commission, funding of the Board comes from fees and assessments charged to bond dealers rather than from the federal government.
The Board has authority comparable to other self-regulating organizations such as the New York and American Stock Exchanges and Nasdaq. Thus, the Board is authorized to make rules to prevent fraudulent and manipulative acts and practices and to promote fair trading practices regarding municipal securities. Such rules are adopted after review by the Securities and Exchange Commission and publication in the Federal Register. Enforcement of the rules is delegated to the National Association of Securities Dealers for securities firms subject to the rules. Enforcement of the Board’s rules that are applicable to banks has been delegated to the Federal Deposit Insurance Corporation, the Federal Reserve Board, and the Comptroller of the Currency.