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Seg. Reg. Outline - Choi - Fall 2006 Building a Policy Argument
SHAPING: How will the rule impact society when it is put into affect?
a) Cost Benefits: future consequences, who will gain and who will
lose
b) Impact on Rights: establishing or undermining them? ADMINISTRABILITY: How is rule implemented?
a) Will it actually work in practice
-is the new or old rule unclear
b) Will it actually be followed
c) Rules v Standards Problem
Rules: Bright line, but rigid, easier to predict, over-
deterrence or under-deterrence
Standards: Case by case, amorphous, flexible, might be more
right but the risk of getting it wrong, less predictive FUNDAMENTAL FAIRNESS: Elements of morality and justice
a) Unfairness of a Change: How will the transition period be handled?
-Reliance on the old rule
b) Treating Like Cases Alike: How will it fit with other rules of
society?
1) uniformity with other states
-versus promoting experimentation (Federalism)
2) fairness across social categories
c) Merit vs Equality
1) Meritocracy: accept unequal distribution as something to
promote the social good
2) Egalitarian: powerful aspect of our society, especially for
the necessities of life INSTITUTIONAL ROLE: What are their roles, are they best suited for it?
a) Is this normally for judges of Legislators
-Will it undermine either institution to be doing it?
b) Who is best at doing it
-notion that legislators are better at understanding impact
since they have debates, reflect a greater diversity, and study
things thoroughly NON- INTERFERENCE: Is this something government should be doing?
a) Laissez -faire: let people be
b) Interventionists: governments job is to protect people from
tyranny
c) Will this action undermine the authority of government as a whole
1) because it won't respond to the injustice
2) because it has created further injustice I. INTRODUCTION . 2 Key Regulations:
o Sec. Act of '33: Regulates Primary Transactions
o Exchange Act of '34: Regulates Secondary Transactions . Purposes of Sec Regulation
1) Informing Investors. Why do investors need information
a. Intangibility - Security market prices are based on
unpredictable future cash flows. Without information,
investors would not know how to value these cash flows.
b. Homogeneity: Since investors all want the same information
to make money, the Securities regime is an easy source for
that homogeneity.
c. Collective Action Problem: It's hard for investors to get
together to collect the pertinent info on markets.
Therefore, there is value in a Securities regime that
collects and disseminates the info.
d. Centrality of Securities Market: Having a Securities
regime allows companies who could not otherwise afford to
disseminate their information to be introduced to the
public.
e. Asymmetrical Information: Managers and insiders know more
than the public. The Securities Regime acts to smooth that
asymmetry.
f. Capital Markets: It's important to track the flow of money
through the markets. Therefore, consumers should get the
most valuable things at the best price.
g. Efficient Market Hypothesis: You would need to know less
information in the case of a seasoned company based on this
theory since all public information is already reflected in
the stock price. Strong vs. Weak form. We disproved the
Strong Form. Otherwise there wouldn't be insider trading.
2) Why not require disclosure of everything?
a. Too Expensive
b. Some things, like trade secrets need to be kept secret
c. Drown: Investors will be overwhelmed sifting through the
irrelevant to find the relevant.
3) Benefits of mandatory disclosure:
a. Creates standard method of information disclosure - easy
for investors and companies
b. Reduces Costs because companies are repeat players
c. Reduces duplicative research by investors and analysts
4) Class Actions
a. Concern for frivolous suits (only one goes to trial
per year)
i. Strong Incentive to Settle: caused by
insurance, avoid paying defense attorney
fees, avoids the cloud of litigation, can be
distracting for management (may get deposed)
ii. Agency Problem: attorneys bear all the cost
and get a contingency fee if they win
iii. Virtually all settle, 1% go to judgment (only
4 in the nineties and the defendant won
each)
iv. CIRCULARITY: the shareholders are the ones who
file and then end up paying out since it comes
from the corporation. The only
difference is the transaction costs of filing
a motion ( THE LEGAL FEES
. Dumb vs. Smart investors
Some believe that investors are completely irrational and create market
bubbles. Others believe that investors are savvy.
. Types of Regulation
1) Disclosure: Require mandatory disclosure from issuers prior to
sale of securities.
. PROBLEM: How do you ensure that investors will read the
info?
. Have GUN JUMPING rules which require mandatory
disclosure at certain times to focus attention on
investors.
. PROBLEM: Mandatory disclosure is cheap for large companies
but expensive for smaller companies.
1) Self-Help: Don't require mandatory disclosure and if investors
aren't satisfied they can simply not buy any more securities
from that company.
. PROBLEM: Although some investors will not buy again, you
cannot guarantee that all investors will find out that
other investors got screwed and stop buying securities.
3) Self-Regulation: Have outside organizations such as the NASD and
SEC monitor the issuers.
. PROBLEM: There might be conflicts of interest. 4) Private Regulation: Have I-Banks review information on issuers
and then make recommendations to public investors. Issuers would
have incentive to disclose on their own since they want I-Bankers,
auditors, underwriters, and attorneys to recommend their stock.
. PROBLEM: Smaller companies who can't afford expensive
underwriters and who aren't covered by analysts would be
shut out.
. PROBLEM: Private Sanctions might not be enough to deter
companies.
1) Merit Regulation: Have a government agency put its seal of
approval on issuers it believes are solid.
. PROBLEM: If investors have no consensus how is the
government to monitor companies?
. PROBLEM: Telling investors what to invest in is too
paternalistic. . Types of Securities:
o Common Stock
o Preferred Stock
o Bonds
Stockholders have the right to future cash flows that are residual
(dividends), left-over (in liquidation) and discretionary. They can also
vote.
Bondholders have the right to fixed and periodic cash flows and first
right in liquidation. No votes. . Valuing Securities
TWO ISSUES:
(1) What will the value of the security be in the future?
(2) How risky is the security?
Why is money worth more now than in the future?
(1) Inflation
(2) Risk
(3) Gratification
(4) Opportunity Cost of not taking the money now is what you could
have spent it on
Formulas:
i. Present Value: the value of the return NOW, at time 0
PV = FV / (1 + r)^n, n is the number of periods
ii. Future Value: the worth in the future at a specific point
FV = PV x (1 + r)^n
iii. Net Present Value Formula:
NPV = -(initial cost) + PV Diversification: accounting for varying risks in securities and investing
in multiple types in order to diversify risk
a. Certain risks are purely diversifiable (example to invest in umbrella
company and lemonade company)
b. Systemic Risks: risks that you cannot diversify (example is the sun
blowing up)
. Ways to Raise Capital
1. Securities
2. Internally - through excess cash
3. Loans II(A). MATERIALITY - (DO THE SECURITIES LAWS APPLY?) . Information is 'Material' if: "there is a substantial likelihood that the
disclosure would have been viewed by the reasonable investor as having
significantly altered the total mix of information made available." - TSC
Industries
. What statements are Material under the above definition? STEP 1: What kind of statement is it and what Rule is Affected (PART I)? 1. Misstatement - Anything you say must be truthful. SOMETIMES "SILENCE IS
KEY" i.e. Basic
2. Omission - Only material if there is a duty to disclose. You may remain
silent or say "no comment" if there is no duty to disclose. E