The Securities Act of 1933

The first of the big 4 securities acts. Like the other 3, the actual name tells you what it does. The Securities Act of 1933 is the act that regulates securities. It is also known as the Paper Act, as it focuses on the prospectus and other paper requirements of issuing securities. It regulates the primary market, the issuer market, where the majority of proceeds go to the issuer of the security.

This is the act that also created the SEC, and gave Regulation T control to the Federal Reserve Board. The SEC (and thru FINRA) will enforce the Regulation T set by the FRB, but do not get it confused, the margin requirements, and all other aspects of Reg T are set by the FRB, not the SEC.

Corporations are required to register with the SEC if their total assets are more than $10 million and their ownership shares are held by more than 500 shareholders. These corporations are called “reporting companies” and are subject to appropriate SEC filing requirements. The corporations, which would be the issuers, have to register with the SEC themselves, along with any actual securities they plan on selling to the public.

Information barriers

Information barriers are generally digital procedures or security measures to help prevent unauthorized people from having information they should not possess. These can also be referred to as “chinese walls” in the industry. The basic idea, is that order information is protected until it is placed. An agent might pick up a large order in the morning they will place in the afternoon, and if another rep see that order, they could place an order before the much larger order, and profit when the price increases due to the large order. Information barriers, are digital security or other type of procedures to prevent that unauthorized rep, from ever seeing that order, until it is “too late” to do anything to profit unethically from it.

Control

When dealing with the activities of people considered “control persons”, which are also known as insiders, the act includes provisions to help protect the public from them abusing their positions. Insiders would include any officer, director, or someone who owns more than 10% of the control equity of the company through stock of convertible securities (remember 5% makes control of an investment company). Persons who become insiders, through promotion or purchase, must report this to the SEC within 10 days of the event that would make them an insider. They will report the actual quantity of shares they own at this time as well. If the insiders ownership numbers change, they have 2 days to report it.

Insiders cannot sell the corporation’s stock short. They can sell other stocks short, but not any company they are an insider/control person of. Insiders are also not allowed to profit from “short-swing” profits, which simply means selling for a profit within 6 months of acquiring the stock. They’d have to return that profit to the company.

Inside trading

Insider trading refers to profiting from non-public, material information. Non-public is exactly what it sounds like, information that is confidential, private, and not in the public sphere. Material information is information that would be deemed important in making an informed investment choice. Whether the CEO likes the color of their new car, might be non-public, but it also is not material. The announcement of the company that the CFO was fired for embezzling, is certainly material, but as it was announced, it also public. It has to be non-public and material to be insider trading.

Material non-public information is clearly something insiders would have. These persons are prohibited from using their confidential knowledge to profit. When it comes to this topic, even clerical, ministerial, and janitorial employees could be considered insiders, depending on what they work and what they might see.

Before they can conduct transactions on any information they have obtained, it must be publicly announced.

It is always a crime to use material non-public information in any securities transactions. Whether or not a profit is realized, if a transaction was initiated by someone with inside information, they are guilty.

They can’t try and outsmart the system by telling their friend to do the trade. Both the tipper and tippee would be guilty. If George is the CEO and possess material information, and he tells Gloria is wife, who tells Monica her hairdresser, who tells Michael her boyfriend, who tells Michelle his mother, and then Michelle goes and buys or sells securities, every single person in that chain can be charged and found guilty.

Consequences of insider trading

Civil penalties are monetary fines. The total amount is up to 3 times the profit gained, or loss avoided, with a minimum that is indexed for inflation, and its precise number won’t be tested. The law states “$1million indexed for inflation”, and that was started years ago, and it appears that it is $2,626,135 in 2025, but again, the precise number won’t be seen.

Criminal penalties include potential jail time. They are not messing around with this. Criminal penalties are fines of up to $5million for individuals, $25 million for corporations, and up to 20 years in jail for the individual persons responsible.

The reason for the “3 times profit gained or loss avoided”, to put it in a more common phrasing, “the SEC pays for rats”. The SEC has a whistleblower program that pays out bounties to people who report it. Under the program, eligible whistleblowers may be able to receive a bounty reward of 10-30% of recovered sanction money.

Restricted list

No matter what a firm tries and does, there will always be time that the firm is in possession of material non-public information about some security. Maybe they are helping the company with a subsequent offering, maybe they are involved in the underwriting, or some similar situation where they acquired the material non-public information. Maybe there is some other reason, but whatever it might be, the firm has material non-public information now. The firm must keep a list of these securities, this “restricted list” that they are not allowed to trade. Insider trading rules work for corporations too. The corporation, its employees and its proprietary trading, are not allowed to deal in any securities on the firm’s restricted list. Related would be securities that the firm believes it may come into insider information about. Similar to before, maybe they are starting to do a new subsequent issue, but haven’t started yet so don’t have the data. They need to monitor trading in these watched securities; they can keep trading, but they need to be careful.

Trust Indenture Act of 1939

The Trust Indenture Act of 1939 (TIA) is a federal law that adds to the Securities Act of 1933 with more specifics regarding the issuance of debt securities, bonds, in the US.

There are many parts of this act, only some of which are likely to be seen.

There must be an independent and qualified trustee to act for the benefit of holders of the securities, and must follow the provisions of the indenture. The indenture is a legal document that all notes, bonds, and debentures must have, an indenture that is qualified under the TIA, in order to be lawfully sold in interstate commerce, unless exempt. If the total bonds are valued at $10m or more they must have an indenture.

In the indenture there are 2 primary parts. The promises, also called covenants. These are legally enforceable rules and conditions, that the issuer agrees to follow in order to help protect the interest of the bondholders. Covenants can be positive or negative. Negative covenants, are restrictions, acting as preventative manner, preventing certain actions the firm could take that would escalate the risk of default example might be certain assets requirement to be held to make sure payments are made. Positive covenants are promises, acts the issuer commits to undertake. Examples include making interest payments on time and in full, following rules and regulations, and things like that. If covenants are broken, the debt could become immediately due.

The second are the processes that would be followed in the event of default.

Underwritings

There are several underwritings that get used, with best efforts and firm commitment being the most common. Underwritings are when an investment bank, those companies that know how to issue securities, how to raise capital, the filing requirements, and all of those details, and use that to assist companies trying to raise capital through the issuance of securities. They work by contract with the issuer, where they are getting some type of share of the proceeds raised in the offering. Best efforts are where the underwriter will do “their best effort” to sell the securities, but if they can’t sell all of the securities, then the unsold shares get returned to the issuer. In best efforts, the underwriters have little risk, and the issuer has the majority of the risk. Firm commitment is when the underwriter simply pays the issuer for all of the shares, and then the underwriters, and their teams, are required to sell it. In firm commitments, the underwriters have all of the risk as they need to sell them now, and the issuer doesn’t have the risk, as they raised all the money they needed.

All-or-none underwriting is when the issuer says that if they don’t sell the entire issuer, just cancel it, and return the money to the investors. If 100% of the issuance isn’t bought, the entire issuance is canceled. Mini-max is another underwriting that is similar, except that instead of 0 or 100%, there is some minimum the issuer will accept. Maybe it’s a $100m issuance; in the case of all-or-none, if they don’t sell all $100m, then the entire issuance is canceled. In the case of mini max, the issuer may say $100m is what they want to issue, but if at least $70m gets issued, continue. In this case if less than $70m of the issuance is sold, the issuance is canceled, but if at least $70m is purchased, then the issuance goes forward.

Syndicates

Underwriters often form groups of underwriters in order to spread the risk around to multiple companies in the case of larger issuings. There will be a syndicate manager, the “head” underwriter of the syndicate. There will be documents that show how the shares will be distributed, and we discuss that in their own section.

Selling group

Underwriters, investment banks, will work with broker-dealers to assist them in actually selling the securities to customers. These broker-dealers are then part of the selling group. There are additional filings, and requirements for selling groups, and they are discussed in their own section as well.

State registrations

Although not majorly tested on FINRA exams, and clearly not directly “federal”, the state registrations and the Uniform Securities Act (USA) do need to be discussed, at least a little. The Uniform Securities Act, is also known as the Blue-Skys Laws. These are a little misnamed, as they are not actually the laws of any state, or any province. They are however, the basis of all of the state securities laws in the United States, Mexico, and the provinces of Canada. These are governed by NASAA, the North American Securities Administrators Association.

With state law, effectively everything needs to register; issuers, broker-dealers, their representatives (known as agents at the state level), investment advisors, and similar persons.

The 3 types of state securities registrations, the primary testable topic by FINRA, are;

• Notice filing - for large companies, for companies that trade on the NYSE, and for all investment companies. This is not technically a registration, as these companies are exempt from state rules; it is “filing notice” that they will be selling in their state, and provide the state administrator with information similar to what was provided to the SEC when they registered.
• Coordination - For mid-size companies, for companies doing dual registration (state and federal).
• Qualification - For intrastate, within one state companies. As well, any company that doesn’t qualify for another type of registration.