Page 137 - Introduction to Business

CHAPTER 3 Business Governance, Ethics, and Social Responsibility 111

ens corporate responsibility by requiring company CEOs and CFOs to be personally
responsible for the accuracy of their company’s financial reports. The law also
strictly limits the ability of a company’s auditors to provide non-auditing services to
the company and requires auditors to report directly to the board of directors rather
than management. Further, the law generally prohibits corporate loans to directors
and executives. It appears that these and other of the law’s provisions strengthen the
hand of corporate boards of directors with respect to better monitoring CEO and other
corporate executive actions and making sure such actions are positively aligned with
shareholder interests. Moreover, by making corporate executives personally account-
able (with strict penalties) for the accuracy of company financial statements, the pos-
sibility of earnings misstatements (and the possibility for executives to flip stock
options in conjunction with such misstatements) appears to be reduced considerably.
One negative aspect of the Sarbanes-Oxley Act, however, is that it has dramatically
increased legal, accounting, investor relations, and other costs for publicly traded
companies, placing significant stress in this regard on smaller public corporations. 18
REGULATION FD. In a major step toward better addressing information asymmetry
problems in the stock markets, the U.S. Securities and Exchange Commission (SEC)
in late 2000 promulgated a new rule entitled Rule FD, or Rule Fair Disclosure. This Rule FD The federal fair disclosure rule
rule went into effect on October 23, 2000, and prohibits so-called selective disclo- prohibiting selective disclosure of
corporate information to certain parties
sure of material information by companies to stock analysts or certain large
investors. Under the new rule, any intentional disclosure of information to selective
individuals must be accompanied by simultaneous public disclosure. The intent of
the rule is to increase investor confidence in the fairness and integrity of the markets
and to prohibit any potential stock market trading based on the selective disclosure.
This rule clearly prohibits company CEOs or CFOs from leaking important informa-
tion to favored large shareholders or stock analysts. Thus, for example, the Schering-
Plough Corporation drug company recently paid a $1 million fine (and its CEO a
personal fine of $50,000) because of special information provided by the CEO to one
of the company’s large mutual fund shareholders in violation of Rule FD. 19
INSIDER TRADING RULES. Rule 10(b)(5) of the SEC Act of 1934 goes beyond Rule FD
to prohibit all insider trading. Under this rule, anyone who gains access to material insider trading Stock trading based on
nonpublic information because of his or her relationship to the corporation cannot material nonpublic information
trade on it without first making public disclosure. For example, the CEO of a company
cannot sell stock on the basis of bad information only he knows without first releas-
ing that information to the public, in which case the stock’s price will likely go down
and prevent the CEO from getting out of the stock at an inflated price. Insider trading
rules also apply to individuals directly tipped by the CEO. Federal law provides for
both civil and criminal penalties for anyone who buys or sells securities while pos-
sessing material nonpublic information. The SEC closely monitors stock trading by
top corporate executives and corporate directors and has special reporting require-
ments for such individuals. The SEC also closely monitors unusual trading patterns
in company stocks generally as a possible signal of inside information leaks.

SHORT-SWING PROFITS LIABILITY. Section 16(b) of the SEC Act of 1934 takes the
inside information trading prohibitions of Section 10(b)(5) a step further. This sec-
tion of the law prohibits all corporate directors, officers, and 10 percent or greater
shareholders from making a profit by buying and selling the company’s stock within
any six-month period, that is, from making what are known as short-swing profits short-swing profits Stock trading profits
in their company’s stock. This rule applies even if there is absolutely no evidence made by corporate insiders within a six-
month period
that the individual traded on any sort of inside information. For example, suppose
theCEOofXYZCorporationbuys500sharesofhiscompany’sstockat$50pershare on

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