CHAPTER 23 Consumer ProtectionRestaurantFederal and state go.docx

CHAPTER 23 Consumer Protection
Restaurant
Federal and state governments have enacted many statutes to
protect consumers from unsafe food items.
Learning Objectives
After studying this chapter, you should be able to:
1. Describe government regulation of food and food additives.
2. Describe government regulation of drugs, cosmetics, and
medicinal devices.
3. Identify and describe unfair and deceptive business practices.
4. Describe the United Nations Biosafety Protocol concerning
genetically altered foods.
5. List and describe consumer financial protection laws.
Chapter Outline
1. Introduction to Consumer Protection
2. Food Safety
1. Case 23.1 • United States of America v. LaGrou Distribution
Systems, Incorporated
3. Food, Drugs, and Cosmetics Safety
1. LANDMARK LAW • Food, Drug, and Cosmetic Act
2. ETHICS • Restaurants Required to Disclose Calories of Food
Items
3. GLOBAL LAW • United Nations Biosafety Protocol for
Genetically Altered Foods
4. Product and Automobile Safety
5. Medical and Health Care Protection
1. LANDMARK LAW • Health Care Reform Act of 2010
6. Unfair and Deceptive Practices
1. CONTEMPORARY ENVIRONMENT • Do-Not-Call Registry
7. Consumer Financial Protection
1. CONTEMPORARY ENVIRONMENT • Consumer Financial
Protection Bureau
2. ETHICS • Credit CARD Act

3. BUSINESS ENVIRONMENT • Dodd-Frank Wall Street
Reform and Consumer Protection Act
“ I should regret to find that the law was powerless to enforce
the most elementary principles of commercial morality.”
—Lord Herschell Reddaway v. Banham (1896)
Introduction to Consumer Protection and Product Safety
Originally, sales transactions in this country were guided by the
principle of caveat emptor(“let the buyer beware”). This led to
abusive practices by businesses that sold adulterated food
products and other unsafe products. In response, federal and
state governments have enacted a variety of statutes that
regulate the safety of food, drugs, cosmetics, toys, vehicles, and
other products. In addition, governments have enacted consumer
financial protection laws that protect consumer-debtors in credit
transactions. These laws are collectively referred to
as consumer protection laws .
consumer protection laws
Federal and state statutes and regulations that promote product
safety and prohibit abusive, unfair, and deceptive business
practices.
This chapter covers consumer protection and product safety
laws.
Food Safety
The safety of food is an important concern in the United States
and worldwide. In the United States, the U.S. Department of
Agriculture (USDA) is the federal administrative agency that is
responsible primarily for regulating meat, poultry, and other
food products. The USDA conducts inspections of food-
processing and storage facilities. The USDA can initiate legal
proceedings against violators.
U.S. Department of Agriculture (USDA)
A federal administrative agency that is responsible for
regulating the safety of meat, poultry, and other food products.
The following case involves a USDA action against a food
storage company.
CASE 23.1 FEDERAL COURT CASE Adulterated Food United

States v. LaGrou Distribution Systems, Incorporated
466 F.3d 585, 2006 U.S. App. Lexis 25986 (2006) United States
Court of Appeals for the Seventh Circuit
“The conditions at LaGrou’s cold storage warehouse at 2101
Pershing Road in Chicago were enough to turn even the most
enthusiastic meat-loving carnivore into a vegetarian.”
—Bauer, Judge
Facts
LaGrou Distribution Systems, Incorporated, operated a cold
storage warehouse and distribution center in Chicago, Illinois.
The warehouse stored raw, fresh, and frozen meat, poultry, and
other food products that were owned by customers who paid
LaGrou to do so. More than 2 million pounds of food went into
and out of the warehouse each day.
The warehouse had a rat problem for a considerable period of
time. LaGrou workers consistently found rodent droppings and
rodent-gnawed products, and they caught rats in traps
throughout the warehouse on a daily basis. The manager of the
warehouse and the president of LaGrou were aware of this
problem and discussed it weekly. The problem became so bad
that workers were assigned to “rat patrols” to search for rats and
to put out traps to catch rats. At one point, the rat patrols were
trapping as many as 50 rats per day. LaGrou did not inform its
customers of the rodent infestation. LaGrou would throw out
products that had been gnawed by rats.
One day, a food inspector for the U.S. Department of
Agriculture (USDA) went to the LaGrou warehouse and
discovered the rat problem. The following morning, 14 USDA
inspectors and representatives of the federal Food and Drug
Administration (FDA) arrived at the warehouse to begin an
extensive investigation. The inspectors found the widespread rat
infestation and the contaminated meat. The contaminated meat
could transmit bacterial, viral, parasitic, and fungal pathogens,
including E. coli and Salmonella, which could cause severe
illness in human beings.
The USDA ordered the warehouse shut down. Of the 22 million

pounds of meat, poultry, and other food products stored at the
warehouse, 8 million pounds were found to be adulterated and
were destroyed. The remaining product had to be treated with
strict decontamination procedures. The U.S. government
brought charges against LaGrou for violating federal food
safety laws. The U.S. district court ordered LaGrou to pay
restitution of $8.2 million to customers who lost product and to
pay a $2 million fine. In addition, it sentenced LaGrou to a five-
year term of probation. LaGrou appealed.
Issue
Has LaGrou knowingly engaged in the improper storage of
meat, poultry, and other food products, in violation of federal
food safety laws?
Language of the Court
The conditions at LaGrou’s cold storage warehouse at 2101
Pershing Road in Chicago were enough to turn even the most
enthusiastic meat-loving carnivore into a vegetarian. According
to Dr. Bonnie Rose, the USDA microbiologist who testified,
LaGrou’s warehouse was the “worst case” she had seen in her
28 years with the USDA. The instructions in this case explained
that in order to convict LaGrou, the jury had to find that an
authorized agent or employee of LaGrou knowingly stored
products under unsanitary conditions. LaGrou’s President,
managers, and several employees were aware of the unsanitary
conditions in the Pershing Road warehouse.
Decision
The U.S. court of appeals upheld the U.S. district court’s
finding that LaGrou had knowingly engaged in the improper
storage of meat, poultry, and other food products, in violation
of federal food safety laws. The court of appeals affirmed the
judgment of the district court, except that it reduced the fine
from $2 million to $1.5 million.
Ethics Questions
1. Did LaGrou management knowingly engage in improper
storage of food products? Do you think that the penalties
imposed on LaGrou were sufficient?

Food, Drugs, and Cosmetics Safety
The Food, Drug, and Cosmetic Act (FDCA or FDC Act)1 is a
federal statute that regulates the safety of foods, drugs,
cosmetics, and medicinal devices. The specific areas regulated
by the FDCA are discusse in the following paragraphs.
Food, Drug, and Cosmetic Act (FDCA or FDC Act)
A federal statute that provides the basis for the regulation of
much of the testing, manufacture, distribution, and sale of
foods, drugs, cosmetics, and medicinal products.
The following feature discusses the Federal Food, Drug, and
Cosmetic Act.
Landmark Law Food, Drug, and Cosmetic Act
The Food, Drug, and Cosmetic Act (FDCA or FDC Act) was
enacted in 1938. This federal statute, as amended, regulates the
testing, manufacture, distribution, and sale of foods, drugs,
cosmetics, and medicinal devices in the United States. The Food
and Drug Administration (FDA) is the federal administrative
agency empowered to enforce the FDCA.
Food and Drug Administration (FDA)
The federal administrative agency that administers and enforces
the federal Food, Drug, and Cosmetic Act and other federal
consumer protection laws.
Before certain food additives, drugs, cosmetics, and medicinal
devices can be sold to the public, they must receive FDA
approval. An applicant must submit to the FDA an application
that contains relevant information about the safety and uses of
the product. The FDA, after considering the evidence, will
either approve or deny the application.
The FDA can seek search warrants and conduct inspections;
obtain orders for the seizure, recall, and condemnation of
products; seek injunctions; and turn over suspected criminal
violations to the U.S. Department of Justice for prosecution.
Critical Legal Thinking
1. What public purpose does the Food and Drug Administration
serve? If it were not for federal food protection laws, do you
think that companies would voluntarily implement food safety

rules comparable to those of federal laws? Why or why not?
Regulation of Food
The FDCA prohibits the shipment, distribution, or sale
of adulterated food. Food is deemed adulterated if it consists in
whole or in part of any “filthy, putrid, or decomposed
substance” or if it is otherwise “unfit for food.” Note that food
does not have to be entirely pure to be distributed or sold; it
only has to be unadulterated.
The FDCA also prohibits false and misleading labeling of food
products. In addition, it mandates affirmative disclosure of
information on food labels, including the name of the food, the
name and place of the manufacturer, a statement of ingredients,
and nutrition content. A manufacturer may be held liable for
deceptive labeling or packaging.
Food Labeling
In 1990, Congress passed a sweeping truth-in-labeling law
called the Nutrition Labeling and Education Act (NLEA) .2 This
act requires food manufacturers and processors to provide
nutrition information on many foods and prohibits them from
making scientifically unsubstantiated health claims.
Nutrition Labeling and Education Act (NLEA)
A federal statute that requires food manufacturers to disclose on
food labels nutritional information about the food.
The NLEA applies to packaged foods and other foods regulated
by the Food and Drug Administration. The law requires food
labels to disclose the number of calories derived from fat and
the amount of dietary fiber, saturated fat, trans fat, cholesterol,
and a variety of other substances contained in the food. The law
also requires the disclosure of uniform information about
serving sizes and nutrients, and it establishes standard
definitions for light (or lite), low fat, fat free, cholesterol
free, lean, natural, organic, and other terms routinely bandied
about by food processors.
The Department of Agriculture adopted consistent labeling
requirements for the meat and poultry products it regulates.
Nutrition labeling for raw fruits and vegetables and raw seafood

is voluntary. Many sellers of these products provide point-of-
purchase nutrition information.
The following ethics feature discusses food labeling at
restaurants.
Ethics Restaurants Required to Disclose Calories of Food Items
Did you know that a Big Mac contains 540 calories, a Domino’s
medium pepperoni pizza 1,660 calories, a hot fudge with
Snickers sundae from Baskin-Robbins 1,000 calories, a
blueberry muffin from Starbucks 450 calories, and a medium-
size bucket of buttered popcorn at the movie theater
approximately 1,000 calories? Well, you will now.
Section 4205 of the Patient Protection and Affordable Health
Care Act of 2010requires restaurants and retail food
establishments with 20 or more locations to disclose calorie
counts of their food items and supply information on how many
calories a healthy person should eat in a day. The disclosures
are required to be made on menus and menu boards, including
drive-through menu boards. The law also applies to vending
machine operators with 20 or more vending machines. The law
is administered by the U.S. Food and Drug Administration, a
federal government agency that is empowered to adopt rules and
regulations to enforce the law.
Ethics Questions
1. Why was this federal law enacted? Do you think that the
required disclosures will change consumer habits?
The following feature discusses an important issue regarding
food processing and safety.
Global Law United Nations Biosafety Protocol for Genetically
Altered Foods
United Nations, New York City
In many countries, the food is not genetically altered. However,
many food processors in the United States and elsewhere around
the world genetically modify some foods by adding genes from
other organisms to help crops grow faster or ward off pests.
Although the companies insist that genetically altered foods are

safe, consumers and many countries began to demand that such
foods be clearly labeled so that buyers could decide for
themselves.
More than 165 countries, including the United States, have
agreed to the United Nations Biosafety Protocol for Genetically
Altered Foods (Biosafety Protocol) . The countries agreed that
all genetically engineered foods would be clearly labeled with
the phrase “May contain living modified organisms.” This
allows consumers to decide whether to purchase such altered
food products. The protocol permits countries to ban imports of
genetically altered foods if they decide that there is not enough
scientific evidence to ensure the product’s safety.
United Nations Biosafety Protocol for Genetically Altered
Goods (Biosafety Protocol)
A United Nations–sponsored protocol that requires signatory
countries to place the label “May contain living modified
organisms” on all genetically engineered foods.
Regulation of Drugs
The FDCA gives the FDA the authority to regulate the testing,
manufacture, distribution, and sale of drugs. The Drug
Amendment to the FDCA ,3 enacted in 1962, gives the FDA
broad powers to license new drugs in the United States. After a
new drug application is filed, the FDA holds a hearing and
investigates the merits of the application. This process can take
many years. The FDA may withdraw approval of any previously
licensed drug.
This law requires all users of prescription and nonprescription
drugs to receive proper directions for use (including the method
and duration of use) and adequate warnings about any related
side effects. The manufacture, distribution, or sale of
adulterated or misbranded drugs is prohibited.
Drug Amendment to the FDCA
A federal law that gives the FDA broad powers to license new
drugs in the United States.
Regulation of Cosmetics
The FDA’s definition of cosmetics includes substances and

preparations for cleansing, altering the appearance of, and
promoting the attractiveness of a person. Eye shadow and other
facial makeup products are examples of cosmetics subject to
FDA regulation. Ordinary household soap is expressly exempted
from this definition.
The FDA has issued regulations that require cosmetics to be
labeled, to disclose ingredients, and to contain warnings if they
are carcinogenic (i.e., cancer causing) or otherwise dangerous to
a person’s health. The manufacture, distribution, or sale of
adulterated or misbranded cosmetics is prohibited. The FDA
may remove from commerce any cosmetics that contain
unsubstantiated claims of preserving youth, increasing virility,
growing hair, and so on.
Regulation of Medicinal Devices
In 1976, Congress enacted the Medicinal Device
Amendment4 to the FDCA. This amendment gives the FDA
authority to regulate medicinal devices such as heart
pacemakers; kidney dialysis machines; defibrillators; surgical
equipment; and other diagnostic, therapeutic, and health
devices. The mislabeling of such devices is prohibited. The
FDA is empowered to remove “quack” devices from the market.
Product and Automobile Safety
In 1972, Congress enacted the Consumer Product Safety Act
(CPSA)5 and created the Consumer Product Safety Commission
(CPSC) . The CPSC is an independent federal administrative
agency empowered to (1) adopt rules and regulations to
interpret and enforce the CPSA, (2) conduct research on the
safety of consumer products, and (3) collect data regarding
injuries caused by consumer products.
Consumer Product Safety Act (CPSA)
A federal statute that regulates potentially dangerous consumer
products and that created the Consumer Product Safety
Commission.
Consumer Product Safety Commission (CPSC)
A federal administrative agency empowered to adopt rules and
regulations to interpret and enforce the Consumer Product

Safety Act.
Health Care Reform Act
A federal statute that increases the number of persons who have
health care insurance in the United States and provides new
protections for insured persons from abusive practices of
insurance companies.
WEB EXERCISE
Visit the website of the Food and Drug Administration,
at www.fda.gov. Click on “Cosmetics.” Then click on “Quiz
Yourself: How Smart Are You About Cosmetics?” Take the
quiz.
Because the CPSC regulates potentially dangerous consumer
products, it issues product safety standards for consumer
products that pose unreasonable risk of injury. If a consumer
product is found to be imminently hazardous—that is, if its use
causes an unreasonable risk of death or serious injury or
illness—the manufacturer can be required to recall, repair, or
replace the product or take other corrective action.
Alternatively, the CPSC can seek injunctions, bring actions to
seize hazardous consumer products, seek civil penalties for
intentional violations of the act or of CPSC rules, and seek
criminal penalties for knowing and willful violations of the act
or of CPSC rules. A private party can sue for an injunction to
prevent violations of the act or of CPSC rules and regulations.
Certain consumer products, including motor vehicles, boats,
aircraft, and firearms, are regulated by other government
agencies.
Medical and Health Care Protection
Many employees and their dependents are covered by health
insurance that is provided by their employers. This makes up a
large proportion of the persons who are covered by health
insurance. Under these insurance programs, the employer may
pay all of the health insurance premiums or part of the
insurance premiums. If the employer pays part of the insurance
premium, the employee pays the remainder. This insurance
covers medical bills, hospital costs, doctors’ fees, the cost of

medicine, and other medical costs. However, many small
employers do not provide health care insurance for their
employees. In 2010, more than 55 million people in the United
States were still left without health insurance.
The following feature discusses the landmark Health Care
Reform Act, a federal statute that was enacted by the U.S.
Congress and signed by the president in 2010.
Landmark Law Health Care Reform Act of 2010
After much public debate, in 2010, Congress enacted the Patient
Protection and Affordable Care Act (PPACA).6 This act was
immediately amended by the Health Care and Education
Reconciliation Act.7 The amended act is commonly referred to
as the Health Care Reform Act . The goal of this act was to
increase the number of persons who have health care insurance
in the United States.
The 2010 Health Care Reform Act mandates that most U.S.
citizens and legal residents purchase “minimal essential” health
care insurance coverage. This can be done through an employer
if a person is employed. However, if an employer does not offer
health insurance, or if a person does not work, then the person
can purchase health insurance from new insurance marketplaces
called exchanges. Persons who do not obtain coverage are
required to pay a tax penalty to the federal government.
Pursuant to the act, the federal government subsidizes health
care premiums for individuals with income up to 400 percent of
the poverty line. The act also creates a tax credit for small-
business employers for contributions made to purchase health
insurance for employees.
The Health Care Reform Act covers more than 30 million
people who were not previously covered by health insurance.
The new health care program is funded through a number of
taxes, assessment of fees, and cuts in government spending for
existing health care programs. The Health Care Reform Act
provides a number of new protections for insured persons.
These protections do the following:
· Prevent insurance companies from denying health care

insurance to individuals with preexisting health conditions
· Prohibit health insurance companies from terminating health
insurance coverage when a person gets sick
· Prohibit insurers from establishing an annual spending cap for
payment of benefits
· Prohibit insurers from imposing lifetime limits on the payment
of benefits
· Require health plans that provide dependent coverage to
continue coverage for a dependent child until the child turns 26
years of age
In 2012, the U.S. Supreme Court held that the mandate that
requires persons to purchase insurance or pay a fine is lawful
under the Taxing Clause of the U.S. Constitution. National
Federation of Independent Business v. Sebelius, Secretary of
Health and Human Services, 132 S.Ct. 2566, 2012 U.S. Lexis
4876 (Supreme Court of the United States, 2012)
WEB EXERCISE
Go to the website of the Federal Trade Commission,
at www.ftc.gov. Click on “Consumer Protection” and then read
“Today’s Tip.”
Unfair and Deceptive Practices
The Federal Trade Commission Act (FTC Act) was enacted in
1914.8 The Federal Trade Commission (FTC) was created the
following year to enforce the FTC Act as well as other federal
consumer protection statutes.
Federal Trade Commission (FTC)
A federal administrative agency empowered to enforce the
Federal Trade Commission Act and other federal consumer
protection statutes.
Section 5 of the FTC Act , as amended, prohibits unfair and
deceptive practices. It has been used extensively to regulate
business conduct. This section gives the FTC the authority to
bring an administrative proceeding to attack a deceptive or
unfair practice. If, after a public administrative hearing, the
FTC finds a violation of Section 5, it may issue a cease-and-
desist order, an affirmative disclosure to consumers, corrective

advertising, or the like. The FTC may sue in state or federal
court to obtain compensation on behalf of consumers. A
decision of the FTC may be appealed to federal court.
Section 5 of the FTC Act
A provision in the FTC Act that prohibits unfair and deceptive
practices.
False and Deceptive Advertising
Advertising is false and deceptive advertising under Section 5
of the FTC Act if it (1) contains misinformation or omits
important information that is likely to mislead a “reasonable
consumer” or (2) makes an unsubstantiated claim (e.g., “This
product is 33 percent better than our competitor’s”). Proof of
actual deception is not required. Statements of opinion and sales
talk (e.g., “This is a great car”) do not constitute false and
deceptive advertising.
Example
Kentucky Fried Chicken entered into an agreement with the
FTC whereby KFC withdrew television commercials in which it
claimed that its “fried chicken can, in fact, be part of a healthy
diet.”
Section 5 of the FTC Act can be used to prohibit unfair and
deceptive business practices. The following feature discusses an
important law that was passed to protect consumers from
unwanted telemarketing phone calls.
Contemporary Environment Do-Not-Call Registry
“The Do-Not-Call Registry lets consumers avoid unwanted sales
pitches that invade the home via telephone.”
—Ebel, Cicuit Judge
In 2003, Congress enacted the Do-Not-Call Implementation
Act,9 which required the Federal Trade Commission (FTC) to
create and administer the National Do-Not-Call Registry .
Consumers can place their telephone numbers on this registry
and free themselves from most unsolicited telemarketing and
commercial telephone calls. Both wire-connected phones and
wireless phones such as cell phones can be registered. The
registry applies only to residential phones and not to business

phones. The FTC can remove telephone numbers that have been
disconnected and reassigned.
Do-Not-Call Registry
A register created by federal law where consumers can add their
phone numbers and free themselves from most unsolicited
telemarketing and commercial telephone calls.
When a person registers her or his phone, it is recorded in the
Do-Not-Call Registry the next day. Telemarketers and other
businesses then have 31 days to remove the customer’s phone
number from their sales call list and cease calling the number.
Registration of a telephone on the Do-Not-Call Registry is
permanent. More than 70 percent of Americans have registered
on the Do-Not-Call Registry.
Charitable organizations, political organizations, parties
conducting surveys, and creditors and collection agencies are
exempt from the registry. Also, an “established business
relationship” exception allows businesses to call a customer for
18 months after they sell or lease goods or services to that
person or conduct a financial transaction with that person. The
Do-Not-Call Registry allows consumers to designate specific
companies not to call them, including those that otherwise
qualify for the established business relationship exemption.
The Do-Not-Call Registry has been found constitutional as a
valid restriction on commercial speech. The court stated, “The
Do-Not-Call Registry lets consumers avoid unwanted sales
pitches that invade the home via telephone.” Mainstream
Marketing Services, Inc. v. Federal Trade Commission, 358
F.3d 1228, 2004 U.S. App. Lexis t2564 (United States Court of
Appeals for the Tenth Circuit)
Consumer Financial Protection
In many consumer credit transactions, the lender is an
institution or party that has greater leverage than the borrower.
In the past, this sometimes led to lenders taking advantage of
debtors. To rectify this problem, the federal government has
enacted many consumer financial protection statutes that protect
debtors from abusive, deceptive, and unfair credit practices.

Many of these consumer financial protection laws are discussed
in the following paragraphs.
Contemporary Environment Consumer Financial Protection
Bureau
In 2010, Congress created a new federal government agency
called the Consumer Financial Protection Bureau (CFPB) . The
bureau has authority to supervise all participants in the
consumer finance and mortgage area including depository
institutions such as commercial and savings banks and
nondepository parties such as insurance companies, mortgage
brokers, credit-counseling firms, debt collectors, and debt
buyers. The bureau provides uniform model forms that covered
parties can use to make required disclosures.
The bureau has authority to prohibit unfair, deceptive, or
abusive acts or practices regarding consumer financial products
and services. The bureau is a watchdog over credit cards, debit
cards, mortgages, payday loans, and other consumer financial
products and services. The automobile industry is exempt from
bureau supervision and is subject to oversight by the Federal
trade Commission (FTC).
The bureau has authority to enforce federal consumer financial
protection laws. The bureau is authorized to adopt rules to
interpret and enforce the provisions of the acts it administers.
The bureau has investigative and subpoena powers and may
refer matters to the U.S. Attorney General for criminal
prosecution.
Truth-in-Lending Act
The Truth-in-Lending Act (TILA)10 is one of the first federal
consumer protection statutes enacted by Congress. The TILA, as
amended, requires creditors to make certain disclosures to
debtors in consumer transactions (e.g., retail installment sales,
automobile loans) and real estate loans on the debtor’s principal
dwelling. The TILA covers only creditors that regularly (1)
extend credit for goods or services to consumers or (2) arrange
such credit in the ordinary course of their business. Consumer
credit is defined as credit extended to natural persons for

personal, family, or household purposes.
WEB EXERCISE
Go to www.donotcall.gov to see how to register your telephone
number in the Do-Not-Call Registry.
Consumer Financial Protection Bureau (CFPB)
A federal administrative agency that is responsible for
enforcing federal consumer financial protection statutes.
Truth-in-Lending Act (TILA)
A federal statute that requires creditors to make certain
disclosures to debtors in consumer transactions and real estate
loans on the debtor’s principal dwelling.
Regulation Z
Regulation Z , an administrative agency regulation, sets forth
detailed rules for compliance with the TILA.11 The TILA and
Regulation Z require the creditor to disclose the following
information to the consumer-debtor:
Regulation Z
A regulation that sets forth detailed rules for compliance with
the TILA.
· Cash price of the product or service
· Down payment and trade-in allowance
· Unpaid cash price
· Finance charge, including interest, points, and other fees paid
for the extension of credit
· Annual percentage rate (APR) of the finance charges
· Charges not included in the finance charge (such as appraisal
fees)
· Total dollar amount financed
· Date the finance charge begins to accrue
· Number, amounts, and due dates of payments
· Description of any security interest
· Penalties to be assessed for delinquent payments and late
charges
· Prepayment penalties
· Comparative costs of credit (optional)
The uniform disclosures required by the TILA and Regulation Z

are intended to help consumers shop for the best credit terms.
Consumer Leasing Act
Consumers often opt to lease consumer products, such as
automobiles, rather than purchase them. The Consumer Leasing
Act (CLA)12 is a federal statute that extends the TILA’s
coverage to lease terms in consumer leases. The CLA applies to
lessors who engage in leasing or arranging leases for consumer
goods in the ordinary course of their business. Casual leases
(such as leases between consumers) are not subject to the CLA.
Creditors that violate the CLA are subject to the civil and
criminal penalties provided in he TILA.
Consumer Leasing Act (CLA)
A federal statute that extends the TILA’s coverage to lease
terms in consumer leases.
Fair Credit Billing Act
The Fair Credit Billing Act (FCBA)13 is a federal statute that
regulates billing errors involving consumer credit. The act
requires that creditors promptly acknowledge in writing
consumer billing complaints and investigate billing errors. The
act prohibits creditors from taking actions that adversely affect
the consumer’s credit standing until the investigation is
completed. The act affords other protection during disputes. The
amendment requires creditors to post payments promptly to the
consumer’s account and either refund overpayments or credit
them to the consumer’s account.
Fair Credit Billing Act
A federal statute requiring that creditors promptly acknowledge
in writing consumer billing complaints and investigate billing
errors and that affords consumer-debtors other protection during
billing disputes.
The following ethics feature discusses the Credit CARD Act of
2009.
Ethics Credit CARD Act
Credit card companies, including banks and other issuers of
credit cards, have long engaged in unfair, abusive, deceptive,
and unethical practices that took advantage of consumer-

debtors; however, most of the practices did not violate the law.
This changed when Congress enacted the Credit Card
Accountability Responsibility and Disclosure Act of 2009 ,
more commonly referred to as the Credit CARD Act.14
Credit Card Accountability Responsibility and Disclosure Act
of 2009 (Credit CARD Act)
A federal statute that requires disclosures to consumers
concerning credit card terms, adds transparency to the creditor-
debtor relationship, and eliminates many of the abusive
practices of credit card issuers.
Here are some of the main provisions of the Credit CARD Act:
· Requires that the terms of the credit-card agreement must be
written in plain English and in no less than 12-point font (thus
avoiding “legalese” and fine-print agreements).
· Credit cards cannot be issued to anyone under the age of 21
(used to be 18) unless they have a cosigner (e.g., parent) or they
can prove they have the means to pay credit card expenses.
· Requires that payments above the minimum payment be
applied to pay higher-interest balances first (previously issuers
applied payments to lower-interest balances first). The
minimum payment can be applied to pay off lowest-interest-rate
balances first.
· Prevents card companies from retroactively increasing interest
rates on existing balances.
· Provides that if a cardholder cancels a card, he or she has the
right to pay off existing balances at the existing interest rate
and existing payment schedule (e.g., current minimum monthly
payment).
· Provides that cardholders who have been subject to an interest
rate increase because of default but then pay on time for six
months must have the interest rate returned to the rate prior to
the rate increase.
· Prohibits the application of the universal default rule from
being applied retroactively to existing balances that the
cardholder has on his or her credit cards. The universal default
rule (which was used extensively by credit-card companies prior

to the act) allowed all credit-card companies with whom a
cardholder had a credit card to raise the interest rate on his or
her card, including on the existing balances, if the cardholder
was late in making a payment to any credit card company. The
act does not eliminate the universal default rule; it allows credit
card companies to apply the rule only to future balances.
· Requires card companies to place a notice on each billing
statement that notifies the cardholder how long it would take to
pay off the existing balance plus interest if the cardholder were
to make minimum payments on the card.
· Requires card companies to place a notice on each billing
statement that notifies the cardholder what monthly payment
would be necessary for the cardholder to pay off the balance
plus interest in 36 months.
The Credit CARD Act does not limit how high an interest rate
can be charged on a credit card. The act does not apply to
commercial or business credit cards. Violations of the act are
subject to criminal prosecution and civil lawsuits.
Ethics Questions
1. Have credit-card companies acted unethically in the past? Is
the universal default rule justified, or was it just greed on the
part of the credit-card companies?
Fair Credit Reporting Act
The Fair Credit Reporting Act (FCRA)15 is a federal statute
that regulates credit reporting companies. This act protects a
consumer who is the subject of a credit report by setting rules
for consumer reporting agencies—that is, credit bureaus that
compile and sell credit reports for a fee. A consumer may
request the following information at any time: (1) the nature
and substance of all the information in his or her credit file, (2)
the sources of this information, and (3) the names of recipients
of his or her credit report.
Fair Credit Reporting Act (FCRA)
A federal statute that protects a consumer who is the subject of
a credit report by setting rules for credit bureaus to follow and
permitting consumers to obtain information from credit

reporting businesses.
If a consumer challenges the accuracy of pertinent information
contained in a credit file, the agency may be compelled to
reinvestigate. If the agency cannot find an error, despite the
consumer’s complaint, the consumer may file a 100-word
written statement of his or her version of the disputed
information. If a consumer reporting agency or user violates the
FCRA, the injured consumer may bring a civil action against the
violator and recover actual damages. The FCRA also provides
for criminal penalties.
The Fair and Accurate Credit Transactions Act16 gives
consumers the right to obtain one free credit report once every
12 months from the three nationwide credit reporting agencies
(Equifax, Experian, TransUnion). Consumers may purchase, for
a reasonable fee, their credit score and how the credit score is
calculated. The act permits consumers to place fraud alerts on
their credit files.
credit report
Information about a person’s credit history that can be secured
from a credit reporting agency.
Fair Debt Collection Practices Act
The Fair Debt Collection Practices Act (FDCPA)17 is a federal
statute that protects consumer-debtors from abusive, deceptive,
and unfair practices used by debt collectors. The FDCPA
expressly prohibits debt collectors from using certain practices:
(1) harassing, abusive, or intimidating tactics (e.g., threats of
violence, obscene or abusive language), (2) false or misleading
misrepresentations (e.g., posing as a police officer or an
attorney), and (3) unfair or unconscionable practices (e.g.,
threatening the debtor with imprisonment).
Fair Debt Collection Practices Act (FDCPA)
A federal act that protects consumer-debtors from abusive,
deceptive, and unfair practices used by debt collectors.
A debt collector is not allowed to contact a debtor in some
circumstances, including the following:
1. At any inconvenient time. The FDCPA provides that

convenient hours are between 8:00 a.m.and 9:00 p.m., unless
this time is otherwise inconvenient for the debtor (e.g., the
debtor works a night shift and sleeps during the day).
2. At inconvenient places, such as at a place of worship or
social events.
3. At the debtor’s place of employment, if the employer objects
to such contact.
4. If the debtor is represented by an attorney.
5. If the debtor gives a written notice to the debt collector that
he or she refuses to pay the debt or does not want the debt
collector to contact him or her again.
The FDCPA limits the contact that a debt collector may have
with third persons other than the debtor’s spouse or parents.
Such contact is strictly limited. Unless the court has given its
approval, third parties can be consulted only for the purpose of
locating a debtor, and a third party can be contacted only once.
A debt collector may not inform a third person that a consumer
owes a debt that is in the process of collection. A debtor may
bring a civil action against a debt collector for intentionally
violating the FDCPA.
Equal Credit Opportunity Act
The Equal Credit Opportunity Act (ECOA)18 is a federal statute
that prohibits discrimination in the extension of credit based on
sex, marital status, race, color, national origin, religion, age, or
receipt of income from public assistance programs. The ECOA
applies to all creditors that extend or arrange credit in the
ordinary course of their business, including banks, savings-and-
loan associations, automobile dealers, real estate brokers,
credit-card issuers, and so on.
Equal Credit Opportunity Act (ECOA)
A federal statute that prohibits discrimination in the extension
of credit based on sex, marital status, race, color, national
origin, religion, age, or receipt of income from public assistance
programs.
Fair Credit and Charge Card Disclosure Act
An amendment to the TILA that requires disclosure of certain

credit terms on credit card and charge card solicitations and
applications.
The creditor must notify the applicant within 30 days regarding
the action taken on a credit application. If the creditor takes
an adverse action (i.e., denies, revokes, or changes the credit
terms), the creditor must provide the applicant with a statement
containing the specific reasons for the action. If a creditor
violates the ECOA, the consumer may bring a civil action
against the creditor and recover actual damages (including
emotional distress and embarrassment).
Fair Credit and Charge Card Disclosure Act
The Fair Credit and Charge Card Disclosure Act19 is a federal
statute that requires disclosure of credit terms on credit card
and charge card solicitations and applications. The regulations
adopted under the act require that any direct written solicitation
to a consumer display, in tabular form, the following
information: (1) the APR, (2) any annual membership fee, (3)
any minimum or fixed finance charge, (4) any transaction
charge for use of the card for purchases, and (5) a statement that
charges are due when the periodic statement is received by the
debtor.
Violations of consumer financial protection statutes are subject
to fines, criminal prosecution, and civil lawsuits.
The following feature discusses the Dodd-Frank Wall Street
Reform and Consumer Protection Act.
Business Environment Dodd-Frank Wall Street Reform and
Consumer Protection Act
In 2010, Congress enacted the Dodd-Frank Wall Street Reform
and Consumer Protection Act (Dodd-Frank Act) .20 The act is
the most sweeping financial reform law enacted since the Great
Depression in the 1930s. Major goals of the act are to regulate
consumer credit and mortgage lending. Two main provisions of
the act that affect consumer financial protection are:
Dodd-Frank Wall Street Reform and Consumer Protection Act
A federal statute that regulates the financial industry and
provides protection to consumers regarding financial products

and services.
· Consumer Financial Protection Act of 2010. Title X of the
Dodd-Frank Act, which is entitled the Consumer Financial
Protection Act of 2010, is designed to increase relevant
disclosure regarding consumer financial products and services
and to eliminate deceptive and abusive loan practices. The act is
also designed to prevent hidden fees and charges. The new law
requires disclosure of relevant information to consumers in
plain language that permits consumers to understand the costs,
benefits, and risks associated with consumer financial products
and services.
· Mortgage Reform and Anti-Predatory Lending Act. Title XIV
of the Dodd-Frank Act, which is entitled the Mortgage Reform
and Anti-Predatory Lending Act, is designed to eliminate many
abusive loan practices and mandates new duties and disclosure
requirements for mortgage lenders. The act requires that
mortgage originators and lenders verify the assets and income
of prospective borrowers, their credit history, employment
status, debt-to-income ratio, and other relevant factors when
making a decision to extend credit. The act puts the burden on
lenders to verify that a borrower can afford to repay the loan for
which he or she has applied. The act provides civil remedies for
borrowers to sue lenders for engaging in deceptive and
predatory practices and for violating the provisions of the act.
CHAPTER
23
Consumer Protection
Restaurant
Federal and state governments h

ave enacted many statutes to protect consumers from unsafe
food items.
Learning Objectives
1.
Describe government regulation of food and food additives.
2.
Describe government regulation of drugs, cosmetics, an
d medicinal devices.
3.
Identify and describe unfair and deceptive business practices.
4.
Describe the United Nations Biosafety Protocol concerning
5.
List and describe consumer financial protection laws.
Chapter Outline
1.
Introduction
to

Consumer
Protection
2.
Food
Safety
1.
Case
23.1
•
United
States
of
America
v.
LaGrou
Distribution
Systems,
Incorporated

3.
Food,
Drugs,
and
Cosmetics
Safety
1.
LANDMARK
LAW
•
Food,
Drug,
and
Cosmetic
Act
CHAPTER 23 Consumer Protection
Restaurant
Federal and state governments have enacted many statutes to
protect consumers from unsafe

food items.
Learning Objectives
1. Describe government regulation of food and food additives.
2. Describe government regulation of drugs, cosmetics, and
medicinal devices.
3. Identify and describe unfair and deceptive business practices.
4. Describe the United Nations Biosafety Protocol concerning
5. List and describe consumer financial protection laws.
Chapter Outline
1. Introduction to Consumer Protection
2. Food Safety
1. Case 23.1 • United States of America v. LaGrou Distribution
Systems, Incorporated
3. Food, Drugs, and Cosmetics Safety
1. LANDMARK LAW • Food, Drug, and Cosmetic Act
CHAPTER 17 Investor Protection and E-Securities Transactions
New York Stock Exchange
This is the home of the New York Stock Exchange (NYSE) in
New York City. The NYSE, nicknamed the Big Board, is the
premier stock exchange in the world. It lists the stocks and
securities of approximately 3,000 of the world’s largest
companies for trading. The origin of the NYSE dates to 1792,
when several stockbrokers met under a buttonwood tree on Wall
Street. The NYSE is located at 11 Wall Street, which has been
designated a National Historic Landmark. The NYSE is now
operated by NYSE Euronext, which was formed when the NYSE
merged with the fully electronic stock exchange Euronext.
Learning Objectives
1. Describe the procedure for going public and how securities
are registered with the Securities and Exchange Commission
(SEC).

2. Describe e-securities transactions and public offerings.
3. Describe the requirements for qualifying for private
placement, intrastate, and small offering exemptions from
registration.
4. Describe insider trading that violates Section 10(b) of the
Securities Exchange Act of 1934.
5. Describe the changes made to securities law by the Jumpstart
Our Business Startups (JOBS) Act and its effect on raising
capital by small businesses.
Chapter Outline
1. Introduction to Investor Protection and E-Securities
Transactions
2. Securities Law
1. LANDMARK LAW • Federal Securities Laws
3. Definition of Security
4. Initial Public Offering: Securities Act of 1933
1. BUSINESS ENVIRONMENT • Facebook’s Initial Public
Offering
2. CONTEMPORARY ENVIRONMENT • Jumpstart Our
Business Startups (JOBS) Act: Emerging Growth Company
5. E-Securities Transactions
1. DIGITAL LAW • Crowdfunding and Funding Portals
6. Exempt Securities
7. Exempt Transactions
8. Trading in Securities: Securities Exchange Act of 1934
9. Insider Trading
1. Case 17.1 • United States v. Bhagat
2. Case 17.2 • United States v. Kluger
3. ETHICS • Stop Trading on Congressional Knowledge Act
10. Short-Swing Profits
11. State “Blue-Sky” Laws
“The insiders here were not trading on an equal footing with the
outside investors.”
—Judge Waterman Securities and Exchange Commission v.
Texas Gulf Sulphur Company 401 F.2d 833, 1968 U.S. App.
Lexis 5796 (1968)

Introduction to Investor Protection and E-Securities
Transactions
Prior to the 1920s and 1930s, the securities markets in this
country were not regulated by the federal government.
Securities were issued and sold to investors with little, if any,
disclosure. Fraud in these transactions was common. To respond
to this lack of regulation, in the early 1930s Congress enacted
federal securities statutes to regulate the securities markets,
including the Securities Act of 1933and the Securities Exchange
Act of 1934. The federal securities statutes were designed to
require disclosure of information to investors, provide for the
regulation of securities issues and trading, and prevent fraud.
Today, many securities are issued over the Internet. These e-
securities transactions are subject to federal regulation.
WEB EXERCISE
Visit the website of the New York Stock Exchange
at www.nyse.com. Click on “About Us” and click on
“Overview.” Read the description of NYS Euronext.
In 2012, Congress enacted the Jumpstart Our Business
Startups (JOBS) Act, to make it easier for smaller businesses to
raise capital, and the Stop Trading on Congressional Knowledge
(STOCK) Act, to prohibit insider trading by government
employees.
This chapter discusses federal securities laws, e-securities
transactions, investor protection, ethics, and securities reform.
Securities Law
The federal and state governments have enacted statutes that
regulate the issuance and trading of securities. These are
referred to collectively as securities law. The primary purpose
of these acts is to promote full disclosure to investors and to
prevent fraud in the issuance and trading of securities. These
federal and state statutes are enforced by federal and state
regulatory authorities, respectively. The following feature
discusses major federal securities statutes.
Landmark Law Federal Securities Laws
Following the stock market crash of 1929, Congress enacted a

series of statutes designed to regulate securities markets.
These federal securities statutes are designed to require
disclosure to investors and prevent securities fraud. The two
primary securities statutes enacted by the federal government,
both of which were enacted during the Great Depression years,
are:
· Securities act of 1933. The Securities Act of 1933 is a federal
statute that regulates primarily the issuance of securities by
companies and other businesses.1 This act applies to original
issue of securities, both initial public offerings (IPOs) by new
public companies and sales of new securities by existing
companies. The primary purpose of this act is to require full and
honest disclosure of information to investors at the time of the
issuance of the securities. The act also prohibits fraud during
the sale of issued securities. Securities are now issued online,
and the 1933 act regulates the issue of securities online.
· Securities exchange act of 1934. The Securities Exchange Act
of 1934 is a federal statute designed primarily to prevent fraud
in the subsequent trading of securities.2This act has been
applied to prohibit insider trading and other frauds in the
purchase and sale of securities in the after markets, such as
trading on securities exchanges and other purchases and sales of
securities. The act also requires continuous reporting—annual
reports, quarterly reports, and other reports—to investors and
the Securities and Exchange Commission (SEC). Securities are
now sold online and on electronic stock exchanges. The 1934
act regulates the purchase and sale of securities online.
These acts have been amended over the years. Additional
federal statutes that promote investor protection and regulate
securities issuance and trading are the Jumpstart Our Business
Startups (JOBS) Act and the Stop Trading on Congressional
Knowledge (STOCK) Act.
Securities and Exchange Commission
The Securities Exchange Act of 1934 created the Securities and
Exchange Commission (SEC) , a federal administrative agency
that is empowered to administer federal securities law. The SEC

is an agency composed of five members who are appointed by
the president. The major responsibilities of the SEC are:
Securities and Exchange Commission (SEC)
The federal administrative agency that is empowered to
administer federal securities laws. The SEC can adopt rules and
regulations to interpret and implement federal securities laws.
WEB EXERCISE
Go to the website of the Securities and Exchange Commission,
at www.sec.gov. Click on “What We Do” and read the
introduction.
· Adopting rules (also called regulations) that further the
purpose of the federal securities statutes. These rules have the
force of law.
· Investigating alleged securities violations and bringing
enforcement actions against suspected violators. These
enforcement actions may include recommendations of criminal
prosecution. Criminal prosecutions of violations of federal
securities laws are brought by the U.S. Department of Justice.
· Bringing a civil action to recover monetary damages from
violators of securities laws. A whistleblower bounty
program allows a person who provides information that leads to
a successful SEC action in which more than $1 million is
recovered to receive 10 percent to 30 percent of the money
collected.
· Regulating the activities of securities brokers and advisors.
This includes registering brokers and advisors and taking
enforcement action against those who violate securities laws.
Definition of Security
Congress has enacted the Securities Act of 1933, the Securities
Exchange Act of 1934, and several other securities statutes to
regulate the issuance and sale of securities. For these federal
statutes to apply, however, a security must first be found.
Federal securities laws define securities as:
security
(1) An interest or instrument that is common stock, preferred

stock, a bond, a debenture, or a warrant; (2) an interest or
instrument that is expressly mentioned in securities acts; or (3)
an investment contract.
· Common securities. Interests or instruments that are
commonly known as securities are common securities.
Examples
Common stock, preferred stock, bonds, debentures, and
warrants are common securities.
· Statutorily defined securities. Interests or instruments that are
expressly mentioned in securities acts are statutorily defined
securities.
Examples
The securities acts specifically define preorganization
subscription agreements; interests in oil, gas, and mineral
rights; and deposit receipts for foreign securities as securities.
· Investment contracts. A statutory term that permits courts to
define investment contracts as securities. The courts apply
the Howey test3 to determine whether an arrangement is an
investment contract and therefore a security. Under this test, an
arrangement is considered an investment contract if there is an
investment of money by an investor in a common enterprise and
the investor expects to make profits based on the sole or
substantial efforts of the promoter or others.
Examples
A limited partnership interest is an investment contract because
the limited partner expects to make money based on the effort
of the general partners. Pyramid schemes where persons give
money to a promoter who promises them a high rate of return on
their investment is an investment contract because the investors
expect to make money from the efforts of the promoter.
investment contract
A flexible standard for defining a security.
Howey test
A test stating that an arrangement is an investment contract if
there is an investment of money by an investor in a common
enterprise and the investor expects to make profits based on the

sole or substantial efforts of the promoter or others.
Mutual funds sell shares to the public, make investments in
stocks and bonds for the long term, and are restricted from
investing in risky investments. Because mutual funds are sold to
the public, they must be registered with the SEC.
CONCEPT SUMMARY Definition of Security
Type of Security
Definition
Common securities
Interests or instruments that are commonly known as securities,
such as common stock, preferred stock, debentures, and
warrants.
Statutorily defined securities
Interests and instruments that are expressly mentioned in
securities acts as being securities, such as interests in oil, gas,
and mineral rights.
Investment contracts
A flexible standard for defining a security. Under
the Howey test, a security exists if an investor invests money in
a common enterprise and expects to make a profit from the
significant efforts of others.
Initial Public Offering: Securities Act of 1933
The Securities Act of 1933 regulates primarily the issuance of
securities by corporations, limited partnerships, and
companies. Section 5 of the Securities Act of 1933 requires
securities offered to the public through the use of the mails or
any facility of interstate commerce to be registered with the
SEC by means of a registration statement and an accompanying
prospectus.
Securities Act of 1933
A federal statute that regulates primarily the issuance of
securities by corporations, limited partnerships, and
associations.
Section 5 of the Securities Act of 1933
A section that requires an issuer to register its securities with
the SEC prior to selling them to the public.

A business or party selling securities to the public is called
an issuer. An issuer may be a new company (e.g., Facebook)
that is selling securities to the public for the first time. This is
referred to as going public. Or the issuer may be an established
company (e.g., General Motors Corporation) that sells a new
security to the public. The issuance of securities by an issuer is
called an initial public offering (IPO) .
initial public offering (IPO)
The sale of securities by an issuer to the public.
Many issuers of securities employ investment bankers, which
are independent securities companies, to sell their securities to
the public. Issuers pay a fee to investment bankers for this
service.
Registration Statement
A company that is issuing securities to the public must file a
written registration statement with the SEC. The general form
for registering with the SEC is called Form S-1. The issuer’s
lawyer normally prepares the S-1 filing registration statement
with the help of the issuer’s managers, accountants,
underwriters, and other professionals. The registration
statement is filed electronically with the SEC.
registration statement
A document that an issuer of securities files with the SEC and
that contains required information about the issuer, the
securities to be issued, and other relevant information.
A registration statement must contain descriptions of (1) the
securities being offered for sale; (2) the registrant’s business;
(3) the management of the registrant, including compensation,
stock options and benefits, and material transactions with the
registrant; (4) pending litigation; (5) how the proceeds from the
offering will be used; (6) government regulation; (7) the degree
of competition in the industry; and (8) any special risk factors.
In addition, a registration statement must be accompanied by
financial statements certified by certified public accountants.
Registration statements usually become effective 20 business
days after they are filed unless the SEC requires additional

information to be disclosed. A new 20-day period begins each
time a registration statement is amended. At the registrant’s
request, the SEC may accelerate the effective date (i.e., not
require the registrant to wait 20 days after the last amendment is
filed). The date that the registration becomes effective is called
the effective date.
The SEC does not pass judgment on the merits of the securities
offered. It decides only whether the issuer has met the
disclosure requirements.
Prospectus
A preliminary prospectus is a written disclosure document that
must be submitted to the SEC along with the registration
statement. A prospectus contains much of the information
included in the registration statement. This preliminary
prospectus is used as a selling tool by the issuer. It is provided
to prospective investors to enable them to evaluate the financial
risk of an investment. The issuer must make a final
prospectus (which includes the final price of the securities and
any amendments required by the SEC) available to purchasers
before or at the time of purchase. The issuer can make the final
prospectus available on a website.
preliminary prospectus
A written disclosure document that must be submitted to the
SEC along with the registration statement and given to
prospective purchasers of the securities.
WEB EXERCISE
Go to the New York Stock Exchange website,
at www.nyse.com/about/listed/IPO_Index.html, to view the
“IPO Showcase” list of the most recent IPOs. What is the most
recent listing? Click on the company's name and read the brief
history of the company.
A prospectus must contain the following language in capital
letters and bold (usually red) type:
THESE SECURITIES HAVE NOT BEEN APPROVED OR
DISAPPROVED BY THE SECURITIES AND EXCHANGE
COMMISSION OR ANY STATE SECURITIES COMMISSION

NOR HAS THE SECURITIES AND EXCHANGE
COMMISSION OR ANY STATE SECURITIES COMMISSION
PASSED UPON THE ACCURACY OR ADEQUACY OF THIS
PROSPECTUS. ANY REPRESENTATION TO THE
CONTRARY IS A CRIMINAL OFFENSE.
The following feature discusses the initial public offering of
Facebook, Inc.
Business Environment Facebook’s Initial Public Offering
Facebook is a social networking service that was launched in
2004. Facebook has more than 1 billion users worldwide who
post billions of comments and hundreds of millions of
photographs daily using the Facebook network.
Facebook originally sold stock to several personal and
institutional investors, but the company remained a privately
held company for eight years. In 2012, Facebook, Inc., went
public by issuing shares in an initial public offering (IPO). In
the IPO, 421,233,615 shares of Facebook, Inc., were sold to the
public. Of this amount, the company sold 180,000,000 shares,
and insiders, including its owner Mark Zuckerberg, sold
241,233,615 shares. The company received the proceeds for the
shares it sold, and the individuals and institutional shareholders
received the proceeds for the shares they sold. The Facebook
IPO was one of the largest in U.S. history. The offering share
price was $38.00.
Prior to the IPO, the company created a dual-class stock
structure. Zukerberg and the other insiders converted shares to
Class B stock. Class A stock was sold to the public in the IPO.
Class B stock is entitled to 10 votes per share, while class A
stock is entitled to 1 vote per share. After the IPO, the holders
of Class B stock controlled 96 percent of the voting power of
the company, with Zuckerberg controlling 55.9 percent of the
voting power of the company.
As a public company, Facebook, Inc., will have to file annual,
quarterly, and other reports with the Securities and Exchange
Commission (SEC) and make public disclosures to the SEC and
its shareholders. The shares of Facebook, Inc., are traded on

NASDAQ under the symbol FB.
The cover page of Facebook's prospectus appears
in Exhibit 17.1.
Filed Pursuant to Rule 424(b)(4)
Registration No. 333-179287
PROSPECTUS
Facebook, Inc. is offering 180,000,000 shares of its Class A
common stock and the selling stockholders are offering
241,233,615 shares of Class A common stock. We will not
receive any proceeds from the sale of shares by the selling
stockholders. This is our initial public offering and no public
market currently exists for our shares of Class A common stock.
We have two classes of common stock, Class A common stock
and Class B common stock. The rights of the holders of Class A
common stock and Class B common stock are identical, except
voting and conversion rights. Each share of Class A common
stock is entitled to one vote. Each share of Class B common
stock is entitled to ten votes and is convertible at any time into
one share of Class A common stock. The holders of our
outstanding shares of Class B common stock will hold
approximately 96.0% of the voting power of our outstanding
capital stock following this offering, and our founder,
Chairman, and CEO, Mark Zuckerberg, will hold or have the
ability to control approximately 55.9% of the voting power of
our outstanding capital stock following this offering.
Our Class A common stock has been approved for listing on the
NASDAQ Global Select Market under the symbol “FB.”
We are a “controlled company” under the corporate governance
rules for NASDAQ-listed companies, and our board of directors
has determined not to have an independent nominating function
and instead to have the full board of directors be directly
responsible for nominating members of our board.
Investing in our Class A common stock involves risks. See
“Risk Factors” beginning on page 12.
PRICE $38.00 A SHARE

Price to Public
Underwriting Discounts and Commissions
Proceeds to Facebook
Proceeds to Selling Stockholders
Per share
$38.00
$0.418
$37.582
$37.582
Total
$16,006,877,370
$176,075,651
$6,764,760,000
$9,066,041,719
We and the selling stockholders have granted the underwriters
the right to purchase up to an additional 63,185,042 shares of
Class A common stock to cover over-allotments.
The Securities and Exchange Commission and state regulators
have not approved or disapproved of these securities, or
determined if this prospectus is truthful or complete. Any
representation to the contrary is a criminal offense.
The underwriters expect to deliver the shares of Class A
common stock to purchasers on May 22, 2012.
MORGAN STANLEY J.P. MORGAN GOLDMAN, SACHS &
CO.
May 17, 2012
Exhibit 17.1 Facebook, Inc., Prospectus
Examples
Twitter, Inc., an online social networking and microblogging
service, went public in 2013 at $26 per share. Alibaba Group
Holding Limited, a China-based company that operates various
e-commerce businesses, went public in 2014 at $68 per share.
Both companies are listed on the New York Stock Exchange;
Twitter is listed under the stock symbol TWTR, and Alibaba is
listed under the stock symbol BABA.

WEB EXERCISE
Go to finance.yahoo.com. Enter the symbol “FB” and click.
What is Facebook stock currently selling at? Enter the symbol
“TWTR” and click. What is Twitter stock currently selling at?
Enter the symbol BABA and click. What is Alibaba stock
currently selling at?
Small Company Offering Registration (SCOR)
A method for small companies to sell up to $1 million of
securities during a 12-month period to the public by using a
question-and-answer disclosure form called Form U-7.
Sale of Unregistered Securities
Sale of securities that should have been registered with the SEC
but were not violates the Securities Act of 1933. Investors who
purchased such unregistered securities can rescind their
purchase and recover damages. The U.S. government can
impose criminal penalties on any person who willfully violates
the Securities Act of 1933.
Example
Space Corporation sells shares of its stock to the public at $8.00
per share. Within months, the price of the stock drops to $2.00.
Space Corporation did not register its stock offering with the
SEC. Because there has been a sale of unregistered securities in
this example, the purchasers can rescind their purchase of the
stock and get their money back (which is often highly unlikely).
If the management of Space Corporation did not register the
securities willfully, the U.S. government can file a criminal
lawsuit to seek criminal penalties.
Regulation A Offering
The JOBS Act amends Regulation A to permit nonreporting
companies to sell up to $50 million of securities (the SEC can
increase the amount every two years) to the public during a 12-
month period, pursuant to a simplified registration with the
SEC. Issuers must file an offering statement with the SEC. An
offering statement requires less disclosure than a registration
statement and is less costly to prepare. Investors must be
provided with an offering circular prior to the purchase of

securities.
Regulation A
A regulation that permits an issuer to sell $50 million of
securities pursuant to a simplified registration process.
A Regulation A offering is a public offering. The offering may
have an unlimited number of purchasers who do not have to be
accredited investors. The issuer can advertise the sale of the
security. There are no resale restrictions on the securities, so
the investor can immediately sell the securities. Thus,
Regulation A permits a company to conduct a mini–public
offering and have a public trading market in its securities.
Issuers of securities under Regulation A must submit audited
financial statements with the SEC annually.
Small Company Offering Registration (SCOR)
Small businesses often need to raise capital and must find
public investors to buy company stock. The SEC has adopted
the Small Company Offering Registration (SCOR) for
companies proposing to raise $1 million or less in any 12-month
period from a public offering of securities. The SEC requires
that a SCOR form (Form U-7) be completed by the company and
be made available to potential investors. Form U-7 is a
question-and-answer disclosure form that small businesses can
complete and file without the services of an expensive securities
lawyer. Form U-7 doubles as a prospectus.
WEB EXERCISE
Go to http://com.ohio.gov/secu/docsU-7.pdf. Review this Form
U-7 to determine what information an issuer must provide when
completing the form.
SCOR form questions require the issuer to develop a business
plan that states specific company goals and how it intends to
reach them. The SCOR form is available only to domestic
businesses. The offering price of the common stock of a SCOR
offering may not be less than $5 per share. Although qualifying
as an exemption from federal registration, SCOR requires the
offering to be registered with the state. Most states have
adopted this form of registration.

The following feature discusses the Jumpstart Our Business
Startups (JOBS) Act of 2012.
Contemporary Environment Jumpstart Our Business Startups
(JOBS) Act: Emerging Growth Company
In 2012, Congress enacted the Jumpstart Our Business Startups
Act (JOBS) Act.4 The purpose of this federal statute is designed
to make it easier for startup companies to raise capital through
initial public offerings (IPOs).
Jumpstart Our Business Startups (JOBS) Act
A federal statute that is designed to make it easier for startup
companies to raise capital through securities offerings.
The JOBS Act creates a new class of public company and a new
category of issuer under federal securities laws called
the emerging growth company (EGC) . EGC status is often
referred to as the IPO on-ramp. Most entrepreneurial and high-
tech companies who are planning to do an initial public offering
of securities qualify for this new status, whereas previously
they would have been subject to the securities law provisions
applicable to much larger companies.
For an existing company to qualify as an EGC, the company
must have (1) not gone public more than five years ago, (2) less
than $1 billion in annual revenue (to be indexed for inflation
every five years), (3) issued no more than $1 billion in debt,
and (4) less than $700 million in stock outstanding after an IPO.
These companies are not the extremely large corporations that
are listed on the New York Stock Exchange (NYSE) or even the
size of most companies listed on the NASDAQ stock exchange
(although a few companies the size of an EGC are listed on
NASDAQ).
By qualifying as an EGC, the company is exempt from a broad
range of requirements typically imposed on companies pursuing
an IPO. The main benefits for qualifying as an EGC are the
following:
· An EGC may submit a confidential draft registration
statement with the SEC for review by SEC staff. This
confidential filing allows companies, if they choose to do so, to

withdraw a proposed IPO without having to disclose
confidential business information.
· An EGC is subject to dramatically reduced IPO
communication restrictions: An EGC may communicate with
institutional accredited investors to test the waters to see if
there is enough interest in its IPO before going forward with it.
· An EGC needs to provide only two years of audited financial
statements when filing an IPO registration to issue securities,
not the three years of audited financial statements that would
have previously been required.
· Qualifying as an EGC frees the company from the restriction
of the Sarbanes-Oxley Act that prohibits investment banks and
research analysts of the same firm from communication with
each other.
· Qualification allows EGCs to file for registration of securities
using a streamlined process and reduced disclosure of financial
information than is true for non-EGC IPOs.
The JOBS Act provisions help EGCs to decide whether to go
public and significantly reduces the costs if they choose to go
public. A company can retain EGC status for only five years
after its IPO. The majority of companies that choose to go
public qualify to do so as an EGC.
Well-Known Seasoned Issuer
The public has access to substantial historical and current
information and financial data about the largest public
companies. In 2005, the SEC created a new category of issuer
called a well-known seasoned investor (WKSI). To qualify as a
WKSI, an issuer must have either (1) issued $1 billion of
securities in the previous three years or (2) at least $700 million
of outstanding equity securities owned by nonaffiliate investors.
Because of their size and presence in the market, WKSIs are
granted substantial flexibility of communication not provided to
other issuers. In addition to a statutory prospectus, a WKSI can
release factual information, forward-looking information,
electronic communications, and free-writing prospectuses
without significant restrictions during the entire offering period.

A WKSI can file a simplified registration statement with the
SEC and immediately begin selling the registered securities.
emerging growth company (EGC)
A class of public company created by the JOBS Act that may
issue securities pursuant to specific rules under federal
securities laws.
Civil Liability: Section 11 of the Securities Act of 1933
Private parties who have been injured by certain registration
statement violations by an issuer or others may bring a civil
action against the violator under Section 11 of the Securities
Act of 1933 . Plaintiffs may recover monetary damages when a
registration statement, on its effective date, misstates or omits a
material fact. Civil liability under Section 11 is imposed on
those who (1) defraud investors intentionally or (2) are
negligent in not discovering the fraud. Thus, the issuer, certain
corporate officers (e.g., chief executive officer, chief financial
officer, chief accounting officer), directors, signers of the
registration statement, underwriters, and experts (e.g.,
accountants who certify financial statements and lawyers who
issue legal opinions that are included in a registration
statement) may be liable.
A provision of the Securities Act of 1933 that imposes civil
liability on persons who intentionally defraud investors by
making misrepresentations or omissions of material facts in the
registration statement or who are negligent for not discovering
the fraud.
All defendants except the issuer may assert a due diligence
defense against the imposition of Section 11 liability. If this
defense is proven, the defendant is not liable. To establish a due
diligence defense, the defendant must prove that, after
reasonable investigation, he or she had reasonable grounds to
believe and did believe that, at the time the registration
statement became effective, the statements contained therein
were true and there was no omission of material facts.
due diligence defense

A defense to a Section 11 action that, if proven, makes the
defendant not liable.
Example
In the classic case Escott v. BarChris Construction
Corporation,5 the company was going to issue a new bond to the
public. The company prepared financial statements wherein the
company overstated current assets, understated current
liabilities, overstated sales, overstated gross profits, overstated
the backlog of orders, did not disclose loans to officers, did not
disclose customer delinquencies in paying for goods, and lied
about the use of the proceeds from the offering. The company
gave these financial statements to its auditors, Peat, Marwick,
Mitchell & Co. (Peat Marwick), who did not discover the lies.
Peat Marwick certified the financial statements that became part
of the registration statement filed with the SEC.
The bonds were sold to the public. One year later, the company
filed for bankruptcy. The bondholders sued Russo, the chief
executive officer (CEO) of BarChris; Vitolo and Puglies, the
founders of the business and the president and vice president,
respectively; Trilling, the controller; and Peat Marwick, the
auditors. Each defendant pleaded the due diligence defense. The
court rejected each of the party’s defenses, finding that the
CEO, president, vice president, and controller were all in
positions to have either created or discovered the
misrepresentations. The court also found that the auditor, Peat
Marwick, did not do a proper investigation and had not proven
its due diligence defense. The court found that the defendants
had violated Section 11 of the Securities Act of 1933 by
submitting misrepresentations and omissions of material facts in
the registration statement filed with the SEC.
A provision of the Securities Act of 1933 that imposes civil
liability on any person who violates the provisions of Section 5
of the act.
Civil Liability: Section 12 of the Securities Act of 1933
Private parties who have been injured by certain securities

violations may bring a civil action against the violator
under Section 12 of the Securities Act of 1933 . Section 12
imposes civil liability on any person who violates the provisions
of Section 5 of the act. Violations include selling securities
pursuant to an unwarranted exemption and making
misrepresentations concerning the offer or sale of securities.
The purchaser’s remedy for a violation of Section 12 is either to
rescind the purchase or to sue for damages.
Example
Technology Inc., a corporation, issues securities to investors
without qualifying for any of the exempt transactions permitted
under the Securities Exchange Act. The securities decrease in
value. In this example, the issuer has issued unregistered
securities to the public. The investors can sue the issuer to
rescind the purchase agreement and get their money back, or
they can sue and recover monetary damages.
SEC Actions: Securities Act of 1933
The SEC may take certain legal actions against parties who
violate the Securities Act of 1933. The SEC may (1) issue
a consent decree whereby a defendant agrees not to violate
securities laws in the future but does not admit to having
violated securities laws in the past; (2) bring an action in U.S.
district court to obtain an injunction to stop challenged conduct;
or (3) request the court to grant ancillary relief, such
as disgorgement of profits by the defendant.
Criminal Liability: Section 24 of the Securities Act of 1933
Section 24 of the Securities Act of 1933 imposes criminal
liability on any person who willfullyviolates either the act or
the rules and regulations adopted thereunder.6 A violator may
be fined, imprisoned, or both. Criminal actions are brought by
the Department of Justice.
A provision of the Securities Act of 1933 that imposes criminal
liability on any person who willfully violates the 1933 act or
the rules or regulations adopted thereunder.
E-Securities Transactions

The Internet has become an important vehicle of the disclosure
of information about companies, online trading, and the public
issuance of securities. Securities—stocks and bonds—are
purchased and sold online worldwide by millions of persons and
businesses each day. Individuals and businesses can open
accounts at online stock brokers, such as Charles Schwab,
Ameritrade, and others, and freely trade securities and manage
their accounts online. Electronic securities transactions, or e-
securities transactions, are becoming commonplace in
disseminating information to investors, trading in securities,
and issuing stocks and other securities to the public. Trading in
e-securities transactions will become an even more important
method for offering, selling, and purchasing securities.
E-Securities Exchanges
The New York Stock Exchange (NYSE) is operated by NYSE
Euronext, which was formed when the NYSE merged with the
fully electronic stock exchange Euronext. The NYSE lists the
stocks and securities of approximately 3,000 of the world’s
largest companies for trading. These companies include Ford
Motor Company, IBM Corporation, The Coca-Cola Company,
China Mobile Communications Corporation, and others.
The National Association of Securities Dealers Automated
Quotation System (NASDAQ) is an electronic stock market.
NASDAQ has the largest trading volume of any securities
exchange in the world. More than 3,000 companies are traded
on NASDAQ, including companies such as Microsoft
Corporation; Yahoo! Inc.; Starbucks Corporation; Amazon.com,
Inc.; Facebook, Inc.; and eBay Inc., as well as companies from
China, India, and other countries around the world. NASDAQ,
which is located in New York City, owns interests in electronic
stock exchanges around the world.
EDGAR
Most public company documents—such as annual and quarterly
reports—are now available online. The SEC requires both
foreign and domestic companies to file registration statements,
periodic reports, and other forms on its electronic filing and

forms system, EDGAR , the SEC electronic data and records
system. Anyone can access and download this information for
free.
NASDAQ
NASDAQ is the world’s largest electronic securities exchange.
It lists more than 3,000 U.S. and global companies and
corporations.
EDGAR
The electronic data and record system of the Securities and
Exchange Commission (SEC).
WEB EXERCISE
Visit the website of EDGAR, at www.sec.gov/edgar.shtml.Click
on “About EDGAR.” Read the first two paragraphs of
“Important Information About EDGAR.”
E-Public Offerings
Companies are now issuing shares of stock over the Internet.
This includes companies that are making electronic initial
public offerings, or e-initial public offerings (e-IPOs), by
selling stock to the public for the first time. E-securities
offerings provide an efficient way to distribute securities to the
public. Google Inc. conducted its IPO online.
The following feature discusses a new electronic method for
issuing securities to the public.
Digital Law Crowdfunding and Funding Portals
The JOBS Act created a new funding mechanism
called crowdfunding for entrepreneurs and small businesses to
raise small amounts of capital from public investors using
online portals. Crowdfunding can be used by small companies
that do not want to meet the requirements and expense of
issuing securities pursuant to a registered offering and do not
qualify for or do not wish to comply with the restrictions of any
of the exemptions from registration.
The JOBS Act permits securities of an issuer to be sold to the
public using an intermediary's funding portal , which is an
Internet website. A funding portal, the website operator, must

register with the SEC. Many crowdfunding portals have
launched to fill this role.
Crowdfunding allows small companies to raise up to $1 million
during a 12-month period from many small-dollar investors
through Web-based platforms. The JOBS Act sets limits on how
much money an individual can spend purchasing securities sold
pursuant to the crowdfunding provision. The yearly aggregate
money each person may invest in offerings of this type is 2
percent of a person's net worth or annual earnings if neither
exceeds $40,000 (at most $1,600) and not more than $10,000 if
a person's annual earnings or net worth exceeds $100,000.
If a company intends to raise less than $100,000, it is not
required to have an accountant review its financial statements.
If the company intends to raise between $100,000 and $500,000,
an independent review of its financial statements must be
conducted by a CPA firm. If the company is going to raise more
than $500,000 of capital, an independent statement audit must
be conducted by a CPA firm. Crowdfunding offerings are
subject to the antifraud provisions of the Securities Act of 1933
and the Securities Exchange Act of 1934.
funding portal
An Internet website that companies may use to issue securities
to the public under the crowdfunding provisions of the JOBS
Act.
crowdfunding
A method that allows small companies to raise capital from
many small-dollar investors through Web-based platforms.
Numerous crowdfunding Websites are available for
entrepreneurs to raise money from a crowd of investors to fund
their small businesses and projects. These Web platforms
include Kickstarter, IndieGoGo, and others. The Web platform
usually charges about 5 percent of the money raised.
Exempt Securities
Certain securities are exempt from registration with the SEC.
These securities are usually offered by certain institutions, or
the securities have certain characteristics that federal laws and

the SEC believe do not require SEC oversight when issued.
Once a security is exempt, it is exempt forever. It does not
matter how many times the security is transferred. Exempt
securities include the following:
exempt securities
Securities that are exempt from registration with the SEC.
· Securities issued by any government in the United States (e.g.,
municipal bonds issued by city governments).
· Short-term notes and drafts that have a maturity date that does
not exceed nine months (e.g., commercial paper issued by
corporations).
· Securities issued by nonprofit issuers, such as religious
institutions, charitable institutions, and colleges and
universities.
· Securities of financial institutions (e.g., banks, savings
associations) that are regulated by the appropriate banking
authorities.
· Insurance and annuity contracts issued by insurance
companies.
· Stock dividends and stock splits.
· Securities issued in a corporate reorganization in which one
security is exchanged for another security.
Critical Legal Thinking
1. What is an exempt transaction? Why does the government
permit securities to be issued without having to register them
with the Securities and Exchange Commission (SEC)?
Exempt Transactions
The Securities Act of 1933 primarily regulates the issuance of
securities by corporations, limited partnerships, other
businesses, and individuals.7 Pursuant to the Securities Act of
1933 and rules adopted by the SEC, some securities that would
otherwise have to be registered with the SEC before being
issued (e.g., common stock) are exempt from registration with
the SEC because the offering meets requirements established by
the act and SEC rules. These are called exempt transactions .
Thus, the securities sold pursuant to an exempt transaction do

not have to be registered with the SEC.
exempt transaction
An offering of securities that do not have to be registered with
the SEC because the offering meets specified requirements
established by securities laws and the SEC.
Example
An issuer sells common stock to investors. Normally, such an
offering would have to be registered with the SEC. If this sale
of common stock is sold in an issuance that qualifies as an
exempt transaction, however, the sale of the common stock does
not have to be registered with the SEC before being issued.
However, exempt transactions that do not have to be registered
with the SEC are subject to the antifraud provisions of the
federal securities laws. Therefore, the issuer must provide
investors with adequate information, such as annual reports,
quarterly reports, proxy statements, and financial statements,
even though a registration statement is not required.
The most widely used transaction exemptions include
the nonissuer exemption, intrastate offering exemption, private
placement exemption, and small offering exemption. These
exempt transactions are discussed in the paragraphs that follow.
Nonissuer Exemption
Nonissuers, such as average investors, do not have to file a
registration statement prior to reselling securities they have
purchased. This nonissuer exemption exists because the
Securities Act of 1933 exempts from registration those
securities transactions not made by an issuer, an underwriter, or
a dealer.
nonissuer exemption
An exemption from registration stating that securities
transactions not made by an issuer, an underwriter, or a dealer
do not have to be registered with the SEC (e.g., normal
purchases of securities by investors).
Example
An investor who owns shares of IBM can resell those shares to
another investor at any time without having to register with the

SEC.
Intrastate Offering Exemption
The Securities Act of 1933 provides an intrastate offering
exemption that permits local businesses to obtain from local
investors capital to be used in the local economy without the
need to register with the SEC.8 There is no limit on the dollar
amount of capital that can be raised pursuant to an intrastate
offering exemption. SEC Rule 147 stipulates that an intrastate
offering can be made only in the one state in which all of the
following requirements are met:9
intrastate offering exemption
An exemption from registration that permits local businesses to
raise capital from local investors to be used in the local
economy without the need to register with the SEC.
1. The issuer must be a resident of the state for which the
exemption is claimed. A corporation is a resident of the state in
which it is incorporated.
2. The issuer must be doing business in that state. This requires
that 80 percent of the issuer’s assets be located in the state, 80
percent of its gross revenues be derived from the state, its
principal office be located in the state, and 80 percent of the
proceeds of the offering be used in the state.
3. The purchasers of the securities must all be residents of that
state.
The intrastate offering exemption assumes that local investors
are sufficiently aware of local conditions to understand the risks
associated with their investment.
Private Placement Exemption
The Securities Act of 1933 provides that an issue of securities
that does not involve a public offering is exempt from the
registration requirements.10SEC Rule 506 —known as
the private placement exemption—allows issuers to raise capital
from an unlimited number of accredited investors without
having to register the offering with the SEC.11 There is no
dollar limit on the securities that can be sold pursuant to this
exemption.

SEC Rule 506 (private placement exemption)
An exemption from registration that permits issuers to raise
capital from an unlimited number of accredited investors and no
more than 35 nonaccredited investors without having to register
the offering with the SEC.
An accredited investor is defined as:12
accredited investor
A person, a corporation, a company, an institution, or an
organization that meets the net worth, income, asset, position,
and other requirements established by the SEC to qualify as an
accredited investor.
· Any natural person who has individual net worth or joint net
worth with a spouse that exceeds $1 million, to be calculated by
excluding the value of the person’s primary residence.
· A natural person with income exceeding $200,000 in each of
the two most recent years or joint income with a spouse
exceeding $300,000 for those years and a reasonable
expectation of the same income level in the current year.
· A charitable organization, a corporation, a partnership, a trust,
or an employee benefit plan with assets exceeding $5 million.
· A bank, an insurance company, a registered investment
company, a business development company, or a small business
investment company.
· Insiders of the issuers, such as directors, executive officers, or
general partners of the company selling the securities.
· A business in which all the equity owners are accredited
investors.
The rationale underlying the private placement exemption is
that accredited investors have the sophistication to understand
the risk involved with the investment and can also afford to lose
their money if the investment fails. The SEC is empowered to
review the definition of accredited investorperiodically and to
make changes to the definition.
The law permits no more than 35 nonaccredited investors to
purchase securities pursuant to a private placement exemption.
These nonaccredited investors are usually friends and family

members of the insiders. Nonaccredited investors must be
sophisticated investors, however, either through their own
experience and education or through representatives (e.g.,
accountants, lawyers, business managers). General selling
efforts, such as general solicitation of or advertising to the
public, are not permitted if there are to be any nonaccredited
investors.
nonaccredited investor
An investor who does not meet the qualifications to be an
accredited investor.
The JOBS Act of 2012 allows an issuer to use public
solicitation and advertising to locate accredited investors as
long as no nonaccredited investors are sold securities. Receipt
of the solicitation or advertisement by a nonaccredited investor
does not destroy this exemption as long as the recipient is not
allowed to purchase securities in the offering. SEC rules require
issuers to verify accredited investor status of investors claiming
to be accredited investors.
Many emerging businesses use the private placement exemption
to raise capital. In addition, many large established companies
use this exemption to sell securities, such as bonds, to a single
investor or a very small group of investors such as pension
funds and investment companies.
Small Offering Exemption
Securities offerings that do not exceed a certain dollar amount
are exempt from registration.13SEC Rule 504 exempts from
registration the sale of securities not exceeding $1 million
during a 12-month period. The securities may be sold to an
unlimited number of accredited and unaccredited investors, but
general selling efforts to the public are not permitted. This is
called the small offering exemption.
SEC Rule 504 (small offering exemption)
An exemption from registration that permits the sale of
securities not exceeding $1 million during a 12-month period.
Restricted Securities
Securities sold pursuant to the intrastate, private placement, and

small offering exemptions are subject to restrictions on resale
for a period of time after the securities are issued. Securities
sold pursuant to these exemptions are called restricted
securities. SEC Rule 147 states that securities issued pursuant
to an intrastate offering exemption cannot be sold to
nonresidents for a period of nine months. SEC Rule 144 states
that securities issued pursuant to the private placement
exemption or the small offering exemption cannot be resold for
six months if the issuer is an SEC reporting company (e.g.,
larger firms) or one year if the issuer is not an SEC reporting
company (e.g., smaller firms).
London, England, the United Kingdom
London is the site of the London Stock Exchange. Established
in 1801, it is the largest stock exchange in Europe. The United
Kingdom is a member of the European Union (EU), a regional
organization of countries in Europe. The EU has adopted
measures to provide uniform contract law in specific economic
sectors. The EU is working on developing a general uniform
contract law for member countries.
Trading in Securities: Securities Exchange Act of 1934
Unlike the Securities Act of 1933, which regulates the original
issuance of securities, the Securities Exchange Act of
1934 regulates primarily subsequent trading.14 It provides for
the registration of certain companies with the SEC, the
continuous filing of periodic reports by these companies to the
SEC, and the regulation of securities exchanges, brokers, and
dealers. It also contains provisions that assess civil and criminal
liability on violators of the 1934 act and rules and regulations
adopted thereunder.
Securities Exchange Act of 1934
A federal statute that regulates primarily trading in securities.
Section 10(b) and Rule 10b-5
Section 10(b) of the Securities Exchange Act of 1934 is one of
the most important sections in the entire 1934 act.15 Section
10(b) prohibits the use of manipulative and deceptive devices in

contravention of the rules and regulations prescribed by the
SEC. Pursuant to its rule-making authority, the SEC has
adopted SEC Rule 10b-5 ,16 which provides the following:
Section 10(b) of the Securities Exchange Act of 1934
A provision of the Securities Exchange Act of 1934 that
prohibits the use of manipulative and deceptive devices in the
purchase or sale of securities in contravention of the rules and
regulations prescribed by the SEC.
SEC Rule 10b-5
A rule adopted by the SEC to clarify the reach of Section 10(b)
against deceptive and fraudulent activities in the purchase and
sale of securities.
It shall be unlawful for any person, directly or indirectly, by use
of any means or instrumentality of interstate commerce or of the
mails, or of any facility of any national securities exchange,
a. to employ any device, scheme, or artifice to defraud,
b. to make any untrue statement of a material fact or to omit to
state a material fact necessary in order to make the statements
made, in light of the circumstances under which they were
made, not misleading, or
c. to engage in any act, practice, or course of business that
operates or would operate as a fraud or deceit upon any person,
in connection with the purchase or sale of any security.
Rule 10b-5 is not restricted to purchases and sales of securities
of reporting companies.17 All transfers of securities, whether
made on a stock exchange, in the over-the-counter market, in a
private sale, or in connection with a merger, are subject to this
rule.18 The U.S. Supreme Court has held that only conduct
involving scienter(intentional conduct) violates Section 10(b)
and Rule 10b-5. Negligent conduct is not a violation.19
scienter
Intentional conduct. Scienter is required for a violation of
Section 10(b) and Rule 10b-5 to occur.
Section 10(b) and Rule 10b-5 require reliance by the injured
party on the misstatement. However, many sales and purchases
of securities occur in open-market transactions (e.g., on stock

exchanges), where there is no direct communication between the
buyer and the seller.
Civil Liability: Section 10(b) of the Securities Exchange Act of
1934
Although Section 10(b) and Rule 10b-5 do not expressly
provide for a private right of action, courts have implied such a
right. Generally, a private plaintiff may bring a civil action and
seek rescission of the securities contract or to recover damages
(e.g., disgorgements of the illegal profits by the defendants)
where there has been intentional conduct that violates Section
10(b) and rules adopted thereunder by the SEC. Private
securities fraud claims must be brought within two years after
discovery or five years after the violation occurs, whichever is
shorter.
SEC Actions: Securities Exchange Act of 1934
The SEC may investigate suspected violations of the Securities
Exchange Act of 1934 and of the rules and regulations adopted
thereunder. The SEC may enter into consent decrees with
defendants, seek injunctions in U.S. district court, or seek court
orders requiring defendants to disgorge illegally gained profits.
In 1984, Congress enacted the Insider Trading Sanctions
Act ,20 which permits the SEC to obtain a civil penalty of up to
three times the illegal profits gained or losses avoided on
insider trading. The fine is payable to the U.S. Treasury. Under
the Sarbanes-Oxley Act, the SEC may issue an order prohibiting
any person who has committed securities fraud from acting as
an officer or a director of a public company.
Insider Trading Sanctions Act
A federal statute that permits the SEC to obtain a civil penalty
of up to three times the illegal benefits received from insider
trading.
Criminal Liability: Section 32 of the Securities Exchange Act of
1934
Section 32 of the Securities Exchange Act of 1934 makes it a
criminal offense to violate willfully the provisions of the act or
the rules and regulations adopted thereunder.21 Under the

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