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American Bar Association - Defending Liberty, Pursuing Justice

SPRING 2011

Vol. 7, No. 3

 

BUSINESS LAW

 

Corporate Counsel Guides: Securities Regulation (Glossary of Terms)

By Thomas Lee Hazen

Blue sky law. Blue sky law is a term used to refer to state securities laws.

Boiler room. Boiler room refers to a brokerage firm that focuses on high-pressure sales practices and various fraudulent activities.

Bucket shop. A variety of boiler room where the customer orders are not actually placed. The orders are bucketed rather than entered in the markets.

Call option. A call option is a contract between a seller (the option writer) and a buyer under which the option buyer has the right to exercise the option and thereby purchase the underlying security at an agreed-on price (the “strike” or “exercise” price). The option will expire unexercised (and hence valueless) unless it is exercised within a specified time period, the last day of which is the expiration date. See also “put option.”

Churning. Churning is an illegal practice when brokers with discretionary authority or control over an account enter into trades to generate commissions.

Cross trade. See “matched order.”

Flipping. Flipping occurs when someone purchases securities as part of a public offering with an intent to sell immediately into a rising aftermarket.

Free writing. Free writing refers to information not contained in a prospectus relating to a company that may be disseminated by a company engaged in a public offering.

Gun jumping. Gun jumping results from premature publicity about an upcoming public offering. Gun jumping is prohibited by 1933 Act § 5(c).

Haircut. Haircut is a discount deducted from the value of securities when computing value for purposes of the net capital requirements for securities broker-dealers (SEC Rule 15c3-1).

Margin. A margin transaction involves buying securities with funds borrowed from the broker. The Federal Reserve Board and the exchanges set the minimum margin requirements.

Market maker. A market maker is a securities dealer that provides firm bid and asked prices for securities. Market makers are regulated by FINRA and originally functioned primarily in the over-the-counter markets but now also make a market for exchange traded securities.

Marking the close. Marking the close is a manipulative practice whereby a portfolio manager artificially inflates the price of stocks held in the portfolio just before the close of trading for the purpose of increasing the portfolio’s value.

Mark-up (and mark-down). A mark-up or mark-down refers to the commission received by a broker-dealer for a retail transaction in the NASDAQ market. A mark-up represents the amount that the customer is charged above the actual purchase price. A mark-down is the amount deducted from the proceeds of the sales price.

Matched order. A “matched” order occurs when orders are entered simultaneously to buy and sell the same security. The mere fact that a broker crosses trades or enters into matched orders does not violate the 1934 Act. In fact, cross-trades can actually benefit the firm’s customers if the savings on commissions are passed on to the customers. However, the cross-trades become problematic when the cost savings are not passed on to the customer.

Over-the-counter. An over-the-counter transaction is one that takes place other than through the facilities of an organized securities exchange.

Painting the tape. Painting the tape is a manipulative practice of reporting fictitious orders to make it appear that real transactions are taking place.

Parking. Parking is a fraudulent practice of parking shares in someone else’s name in order to hide the identity of the true owner.

Post-effective period. The post-effective period is the time after a 1933 Act registration has become effective. Sales of the securities covered by the registration statement are not permitted until the beginning of the post-effective period. During the post-effective period, the prospectus delivery requirements of 1933 Act §§ 5(b), 10 continue to apply.

Prefiling period. The prefiling period is that time shortly before the filing of a registration when all offers to buy and all offers to sell are prohibited by the terms of 1933 Act § 5(a).

Proxy. A power of attorney from a shareholder authorizing the proxy holder to vote the shares owned by a shareholder. Proxy is defined in SEC Rule 14a-1(f) to include any shareholder’s consent or authorization regarding the casting of that shareholder’s vote. Requirements for the appropriate form of the proxy itself can be found in Rule 14a-4.

Prospectus. As defined in 1933 Act § 2(a)(10) is a written offer to sell or one made through other permanent means such as online. During a public offering, a prospectus is subject to the disclosure requirements spelled out in § 10. Also § 5(b) sets forth the circumstances under which a prospectus must be provided to investors.

Proxy solicitation. Solicitation, as defined in SEC Rule 14a-1(l), includes the following: any request for a proxy; any request to execute or not to execute, or to revoke, a proxy; or any communication to shareholders reasonably calculated to result in the procurement, withholding, or revocation of a proxy. Rule 14a-1(l). Rule 14a-2 lists the types of solicitations exempt from the proxy rules. Rule 14a-2. Rule 14a-3 sets forth the types of information that must be included in proxy solicitations. Rule 14a-3.

Pump and dump. A pump and dump scheme is the fraudulent and manipulative practice of hyping particular stocks to bring them to artificially high levels and then dumping the stock into the market.

Put option. A put option gives the option’s buyer the right to exercise the option by selling the underlying security. The put-option seller must purchase the underlying security at the agreed-on price if the option is exercised on or before the expiration date. If the strike price is “out of the money” in comparison with the price of the underlying security, so that it would not make economic sense to exercise the option, the option will simply expire unexercised. See also “call option.”

Odd-lot. An odd-lot refers to a block of shares under 100. Traditionally shares in publicly held companies have been traded in 100 share lots. Transactions in hundred share lots are referred to as round lots.

Quiet period. The quiet period is the time shortly before a 1933 Act registration statement is filed in connection with a public offering (also known as the prefiling period). During the quiet period participants in the offering must be careful not to disseminate information that could be construed as an illegal offer to sell the securities to be covered by the registration statement.

Red herring prospectus. A red herring prospectus is a preliminary prospectus that may be used after the filing of a 1933 Act registration during the waiting period. See SEC Rule 430.

Restricted securities. A restricted security is one that is subject to transfer restrictions. Restricted securities often result from securities that are sold in a private placement as opposed to a public offering.

Safe harbor rule. A safe harbor rule is a rule under which the SEC provides guidance as to how to comply with specific provisions of the securities laws. It is a safe harbor but is not the exclusive way of complying with the applicable law.

Sale against the box. A “sale against the box” takes place when the seller, anticipating a decline in the price of stock she owns, sells it to a buyer at the present market price, but delivers it later, when (she hopes) the market price will have fallen below the sales price, thus creating a paper profit for the seller.

Scalping. Scalping is the illegal practice that occurs when someone touts securities that he owns with the goal of raising the price to increase the value of his holdings.

Secondary offering. A secondary offering occurs when securities are offered as part of a distribution by existing securities holders. In a secondary offering the proceeds of the sale go to the selling shareholders. In contrast, with a primary offering the shares are sold by the issuer and the proceeds go to the company.

Shelf registration. A shelf registration is a 1933 Act registration statement for securities that are going to be offered on a delayed or continuous basis. See SEC Rule 415.

Short sale. A “short sale” takes place when a seller, believing the price of a stock will fall, borrows stock from a lender and sells it to a buyer. Later, the seller buys similar stock to pay back the lender, ideally at a lower price than he received on the sale to the buyer.

Solicitation. See Proxy solicitation.

Specialist. For most of its existence, New York Stock Exchange trading took place through specialist firms who had no retail securities business. Over time the specialist system is giving way to a system based on designated market makers who function much like market makers in the over-the-counter markets.

Spread. The spread is the difference between the bid and the asked price of a security. A market maker makes its commission through the spread by buying at the bid price and then selling the securities at the asked price. See also mark-up and mark-down.

Street name. Securities are held in street name when the brokerage firm holds the securities in their own name for the benefit of the customer as beneficial owner.

Tombstone advertisement. A tombstone ad is the industry term for an identifying statement that simply announces the offering and lists the underwriter.

Underwriter. An underwriter is a broker-dealer or investment banking firm that acts as a wholesaler for a securities distribution. Underwriter status can also result from substantial participation in a securities distribution. See 1933 Act § 2(a)(11).

Waiting period. The waiting period is the time between the filing a 1933 Act registration statement is filed and the time that it becomes effective. Sales of the securities covered by the registration statement are no permitted during the waiting period (1933 Act § 5(a)). Also, during the waiting period, written, online, radio, and television communications must satisfy or be exempt from the prospectus requirements of 1933 Act §§ 5(b), 10.

Warrant. A warrant is a stock option issued by the company itself often as compensation to promoters or as a separate security to be publicly traded. Stock options may also be issued by the company to employees or consultants; these are generally simply referred to as stock options and not as warrants.

Wash sale. A “wash” sale is a fictitious sale where there is no change in beneficial ownership: It is a transaction without the usual profit motive and is designed to give the false impression of market activity when in fact there is none.

Thomas Lee Hazen is the Cary C. Boshamer Distinguished Professor of Law at the University of North Carolina School of Law at Chapel Hill. Professor Hazen joined the Carolina Law faculty in 1980. After graduating from Columbia Law School, he practiced law in New York City until 1974. He then served on the faculty at the University of Nebraska College of Law until 1980, when he moved from Nebraska to Chapel Hill. Prof. Hazen’s writings have been concentrated in the areas of corporate, securities, and commodities law. He has authored leading treatises in those areas and numerous law review articles focusing on securities regulation, corporate law, and corporate governance. He has also written about the use of computers in legal education and contract issues relating to protecting intellectual property rights in computer software. He can be reached at tomhazen@email.unc.edu.

Corporate Counsel Guides: Securities Regulation

Did you find this article helpful? Do you think more information like this would help you? More information is available. This glossary is excerpted from Corporate Counsel Guides: Securities Regulation, 2011, by Thomas Lee Hazen, published by the American Bar Association General Practice, Solo and Small Firm Division. Copyright © 2011 by the American Bar Association. Reprinted with permission. All rights reserved. This information or any or portion thereof may not be copied or disseminated in any form or by any means or stored in an electronic database or retrieval system without the express written consent of the American Bar Association. GP/Solo members can purchase this book at a discount.

 

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