US Listed Companies' Latest Legislation and Internal Control Practices - (Chinese-English Parallel Edition)

Author: Zhang Lu (Translated)
Publisher:
Publish Date: 2006-11-01
Features: The capital market is a major invention of humankind and a significant economic revolution in human history. The well-being it brings to humanity is unparalleled by anything else. The immense role of the capital market lies primarily in its ability to mitigate risks, optimize investment information and resource allocation, improve corporate governance, reduce the impact of information acquisition costs and transaction costs on capital accumulation and technological innovation, thereby greatly promoting economic growth. The emergence of the capital market can alleviate risks. Taking liquidity risk as an example, liquidity risk arises from the uncertainty of converting assets into a medium of exchange. The existence of information asymmetry and transaction costs hinders liquidity, exacerbating liquidity risk, which in turn provides motivation for the emergence of the capital market. The capital market has extremely high liquidity, and financial instruments can be traded at low costs. With the existence of a liquid capital market, people can confidently hold assets in the form of stocks, bonds, etc., and sell them conveniently and quickly when needed, while enterprises can obtain the capital they need for investment. In this way, the capital market converts liquid financial instruments into non-liquid long-term capital investments for production. This solves the problem of insufficient investment in high-return projects, which typically require long-term capital input, but the owners of wealth are unwilling to give up control over their property for extended periods. The progress of the capital market and the reduction of liquidity risk were the main reasons for the Industrial Revolution in Britain, as the products produced in the first few decades of the Industrial Revolution had already been invented. Many inventions and innovations required substantial and long-term capital investment, and without the support of a financial market, technological innovation alone could not have triggered sustained growth. The key new factor driving growth in 18th-century Britain was the liquidity of the capital market. Because the Industrial Revolution required vast and long-term capital investment, without this liquidity conversion, the Industrial Revolution might not have occurred. "Thus, the Industrial Revolution had to wait for the financial revolution." The capital market promotes economic growth by optimizing investment information and resource allocation. Taking the securities market as an example, the securities market can effectively disseminate corporate information. In the securities market, changes in security prices carry and reflect relevant information. The securities market spreads information through public prices, and market participants can interpret the information by observing security prices. Therefore, there is no need to invest resources in information that can be obtained almost immediately. This public-interest-oriented information acquisition allows society to avoid spending resources on obtaining information, enabling more resources to be allocated to investment in production. Moreover, the improvement of information disclosure itself can greatly enhance resource allocation, ensuring that resources flow to the best production technology projects. A century ago, when Friedrich von Bernhardi witnessed the role of the well-functioning British capital market in resource allocation, he marveled: "In Britain, capital always flows certainly and immediately to where it is needed and where it can earn the most, just as water always flows to the level it needs." Since information disclosure has a public-interest nature and is related to the public's confidence in the securities market and the optimization of resource allocation, actions such as manipulating market prices and insider trading should be stopped and severely punished. The securities market also plays a significant role in improving corporate governance. The public trading of stocks in the securities market can effectively reflect corporate information, making it possible to link the compensation of managers to stock prices. Linking a manager's performance in the stock market to their compensation helps align the interests of managers with those of shareholders, thereby improving corporate governance. Similarly, in a developed securities market, mergers and acquisitions are relatively easy. This makes it easier to acquire poorly performing companies, and the results of such acquisitions often involve the dismissal of the acquired company's management. Therefore, developed securities markets provide opportunities to improve corporate governance and penalize poor performers by facilitating mergers and acquisitions of poorly performing companies. The threat of mergers and acquisitions helps align the incentives of managers with those of shareholders to improve corporate operations and promote development. For the capital market to fulfill these functions, certain conditions must be met. The most fundamental condition is to require issuers to make full, truthful, and complete disclosures, enabling investors to overcome information asymmetry and make rational investment decisions based on full awareness, thereby optimizing the allocation of scarce social resources. The fundamental philosophy and core mission of U.S. securities laws also lie in this. The two key components of the U.S. Securities Act of 1933 and the U.S. Securities Exchange Act of 1934 are mandatory disclosure and the prohibition of fraud, with mandatory disclosure including initial disclosure upon public offering and ongoing disclosure after listing. Since full, truthful, and complete disclosure plays a crucial role in achieving the functions of the capital market mentioned above, the prohibition and punishment of false statements, insider trading, market manipulation, and other actions are not only punitive measures against specific behaviors but also aimed at preventing and stopping the erosion of the foundations of the capital market and the broader socioeconomic mechanism, thereby safeguarding public confidence in the capital market. Without open, fair, and just market transactions and the protection of investors, the capital market will inevitably collapse. The enactment and development of U.S. securities laws bear witness to this. The origins of U.S. securities laws can be traced back to centuries of legislation in Britain before the founding of the United States, with the South Sea Bubble (SouthSeaBubble) directly influencing the passage of the Bubble Act of 1720. After the founding of the United States, to curb fraud in the securities market, Kansas led the way in 1911 by regulating public offerings of securities and passing the Blue Sky Law, targeting securities sellers who "easily collected wealth by selling building lots in the blue sky" (sellbuildinglotsintheblueskyinfeesimple). Following this, other states quickly adopted similar measures. The Great Depression of 1929, which swept across the capitalist world, led to the collapse of the U.S. securities market and paralyzed the U.S. economy in the 1930s. However, the patchwork of state laws was ineffective in combating fraud, as many securities issuers exploited the differences in state laws and interstate competition to evade regulation. The 1929 securities market collapse made it clear that a unified, efficient, fair, and orderly securities market required federal legislation. On May 27, 1933, President Franklin D. Roosevelt signed the Federal Securities Act, the first law in U.S. history to regulate securities trading, requiring all new stock offerings to be registered with the Securities and Exchange Commission (SEC) and disclose specific information. From then on, U.S. securities market legislation shifted from state-by-state regulation to federal uniformity. The (Enron) and WorldCom accounting fraud scandals, which came to light in 2001 and led to their respective collapses, severely undermined the credibility of U.S. listed companies and shook the capital market. In response, the U.S. House and Senate swiftly enacted and passed the Public Company Accounting Reform and Investor Protection Act of 2002, known as the Sarbanes-Oxley Act of 2002. This act made significant revisions to the Securities Act of 1933 and the Securities Exchange Act of 1934, and is considered the most significant and impactful U.S. securities legislation affecting listed companies and independent accountants since the 1930s. To date, the U.S. federal securities law system primarily consists of the following legislation: the Securities Act of 1933, the Securities Exchange Act of 1934, the Public Utility Holding Company Act of 1935, the Trust Indenture Act of 1939, the Investment Company Act of 1940, the Investment Advisers Act of 1940, the Securities Investors Protection Act of 1970, and the Public Company Accounting Reform and Investor Protection Act of 2002. Additionally, court decisions from U.S. federal courts and rules (rules) issued by the Securities and Exchange Commission (SEC) also form an important part of the U.S. federal securities legal system. After years of development, U.S. securities laws have become increasingly (perfect), and have had a profound influence on securities laws in many countries, serving as a model for many nations. Due to its effective reflection of the principles of the securities market and its adaptation to the healthy development of the market, U.S. securities laws hold significant reference and (value) for China. The severe problems that have long existed in China's securities market stem from a fundamental misunderstanding of the philosophy of the securities market and the essence and tasks of securities laws. Furthermore, many Chinese companies are already listed in the U.S., and an increasing number are planning to do so, making it necessary for us to understand the U.S. securities legal system. Currently, many Chinese companies have faced lawsuits shortly after listing in the U.S., damaging the image of Chinese companies in the U.S. securities market. Research and mastery of U.S. securities laws require a high-quality translation text, which has long been lacking and needed. Dr. Zhang Lu has long been engaged in research and practice in the field of securities law, possessing both a solid theoretical foundation and extensive practical experience. His rigorous and realistic approach, combined with his deep expertise in U.S. securities laws, ensures the quality of the translation. The translation is quite precise and appropriately reflects the essence of U.S. securities laws, which is truly commendable. Particularly noteworthy is that, at my suggestion, Dr. Zhang Lu translated the Sarbanes-Oxley Act as well, making it possible for the act, including the widely404 (404 provisions), to be presented to the public in Chinese. Personally, I have always held a strong interest in U.S. securities laws. From 2004 to 2005, I was fortunate to study in the United States on a scholarship from the National (Study Abroad Fund), where I researched legal issues related to finance and securities at the Washington University in St. Louis School of Law and the Georgetown University Law Center. I consulted with renowned securities law scholars such as Professor Joel Seligman of the Washington University in St. Louis School of Law (now President of the University of Rochester) and Professor Donald C. Langevoort of Georgetown University Law Center. This deepened my understanding of the (essence) of U.S. securities laws. However, due to time and (limitations), I was unable to turn my research into a published work. The publication of Dr. Zhang Lu's translation is truly a work that resonates with my own research, and I am delighted. I hope that the U.S. securities laws translated by Dr. Zhang Lu can serve as a reference for China to understand U.S. securities laws and contribute to the legal development of China's securities market, bringing about a positive and corrective effect. With these thoughts in mind, I have written a few words in this preface.