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 humanity 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 stems 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 impetus 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 companies 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 in production. This solves the problem of insufficient investment in high-return projects, which typically require long-term capital but are not willing to relinquish control over their assets 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 long-term capital investment, without this liquidity conversion, the Industrial Revolution might not have occurred. "Therefore, the Industrial Revolution had to wait for a 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 pricing, and market participants can interpret the information by observing security prices. Thus, 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 investments in production. Moreover, the improvement of information disclosure itself can significantly enhance resource allocation, ensuring that resources are directed to the best production technology projects. More than a century ago, when observing the role of the well-functioning British capital market in resource allocation, Beghoit remarked: "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 public 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 for improving corporate governance and punishing 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, thereby improving corporate operations and promoting business development. For the capital market to fulfill the above functions, it is not without conditions. 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 with full awareness, thus 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 "1933 Securities Act" and the "1934 Securities Exchange Act" are mandatory disclosure and the prohibition of fraud, with mandatory disclosure including initial disclosure upon public offering and continuous disclosure after listing. Since full, truthful, and complete disclosure plays a crucial role in achieving the above functions of the capital market, the prohibition and punishment of false statements, insider trading, market manipulation, and other practices are not only punitive measures against specific actions but also aimed at preventing and stopping the erosion of the foundations of the capital market and the broader socioeconomic mechanism, as well as maintaining public confidence in the capital market. Therefore, 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 securities offerings and passing the "Blue Sky Law," targeting securities sellers who "easily collected wealth by selling building lots in the blue sky" (sell building lots in the blue sky in fee simple). Following this, other states quickly adopted similar laws. The 1929 global economic crisis, 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 first federal law regulating securities trading in U.S. history, the "Securities Act of 1933," 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 individual state laws to federal government-led uniform legislation. The exposure and subsequent collapse of Enron and WorldCom in 2001 severely damaged the credibility of U.S. listed companies and left the capital market in turmoil. 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 law made significant revisions to the 1933 Securities Act and the 1934 Securities Exchange Act 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," among others. Additionally, court decisions from U.S. federal courts and rules by the Securities and Exchange Commission (SEC) also form an important part of the U.S. federal securities law system. After years of development, U.S. securities laws have become increasingly, exerting a significant influence on securities laws in many countries and serving as a model for them. 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 great reference and for China. The severe problems that have long plagued China's securities market stem from a fundamental misunderstanding of the philosophy of the securities market and the essence and mission of securities laws. Moreover, 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 law system. Currently, many Chinese companies have faced lawsuits shortly after listing in the U.S., affecting the image of Chinese companies in the U.S. securities market. Researching and mastering U.S. securities laws requires 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 pragmatic approach, combined with his deep expertise in U.S. securities laws, ensures the quality of the translation. Reviewing the translated manuscript, the translation is remarkably precise, appropriately reflecting 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 widely 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, where I researched financial and securities law issues at the Washington University in St. Louis School of Law and Georgetown University Law Center. I consulted with renowned securities law scholars, including Dean of the Washington University in St. Louis School of Law (now President of the University of Rochester), Professor Joel Seligman, and Professor Donald C. Langevoort at Georgetown University Law Center, which deepened my understanding of the of U.S. securities laws. However, due to time and resource constraints, I never managed to formalize my research into a published work. The publication of Dr. Zhang Lu's translation is truly a work that resonates with my own research goals, and I am delighted. I hope that the translated U.S. securities laws 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 impact. With these thoughts in mind, I take the liberty of writing a few words in preface.