Notes on the Securities Regulation Code by Prof. Manuel R. Rigueras

JURISTS BAR REVIEW CENTER™ NOTES ON THE SECURITIES REGULATION CODE Prof. Manuel R. Riguera

28 May 2016

HISTORY The first securities law passed in the Philippines was Act No. 2581 which was passed in 1916. The law was popularly known as the Blue Sky Law. The term Blue Sky is a play on the term blue chips whereby unscrupulous persons would sell securities with no more value than the blue sky. The law, like all securities laws, has as one of its main purposes the protection of the public against fraudulent and unscrupulous practices with respect to the sale and purchase of securities. The Securities Act (C.A. No. 83) took effect in 1937. It was patterned after the 1933 Securities Act and the 1934 Securities Exchange Act of the U.S.A. American jurisprudence and securities practice are thus illuminating in understanding our own securities laws. B.P. Blg. 178 or the Revised Securities Act (RSA) took effect in 1982. This was then superseded by R.A. No. 8799 or the Securities Regulation Code (SRC) which became effective in 8 August 2000. PURPOSE -

Protection of the investing public primarily through a system of disclosure and the punishment of fraudulent practices. Development of the capital and securities market.

GOVERNMENT REGULATORY AGENCY -

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The SEC. The Chairman and the Commissioners given 7-year security of tenure in order to insulate them from political influence. SEC has the power to issue CDOs, punish for contempt, issue subpoena duces tecum and summon witnesses. (5.1). SEC’s jurisdiction over cases under Section 5 of PD 902-A transferred to the special commercial courts (RTCs). Purpose is to relieve the SEC of quasijudicial functions and allow it to concentrate on its primary mandate of regulating and developing the securities market. (5.2) S5 PD 902-A: (FIES) o Fraudulent devices or schemes employed by the directors, business associates, officers or partners against the public and the stockholders, partners, members of associations or organizations registered with SEC. o Intra-corporate and intra-partnership controversies; and controversies between the corporation, partnership, or association (CPA), on one hand, and the state, on the other, insofar as it concerns their individual franchise or right to exist as such entity. o Controversies in the election or appointment of directors, trustees, officers or managers of such CPAs. o Petitions of CPAs to be declared in a state of suspension of payments in cases where the CPA is illiquid, or where it is insolvent but is under the management of a rehabilitation receiver or management committee.

2016 Notes on the Securities Regulation Code by Prof. Manuel R. Riguera for Jurists Bar Review Center™. All rights reserved 2016 by Jurists Review Center Inc. Unauthorized reproduction, use, or dissemination is strictly prohibited and shall be prosecuted to the full extent of the law, including administrative complaints with the Office of the Bar Confidant, Supreme Court. Page 1 of 15

Q The annual stockholder’s meeting of Meralco for the election of directors was set for 27 May 2008. In connection therewith, proxies were required to be submitted on or before 17 May and the proxy validation was slated for 22 May. The proxy validation on 22 May was undertaken by Meralco’s assistant corporate secretary Atty. Rosete. The GSIS, a major Meralco stockholder, filed with the SEC an urgent petition seeking to restrain Atty. Rosete from validating proxies in favor of Manuel Lopez and other Meralco executives. Meralco argues that the SEC does not have jurisdiction as election controversies are now cognizable by the Special Commercial Courts under Section 5.2 of the SRC. The GSIS on the other hand argues that the SEC has regulatory and investigatory powers over the issuance and solicitation of proxies pursuant to Section 20 in relation to Section 53 of the SRC. Does the SEC have jurisdiction over the petition? A No. The SEC’s jurisdiction over cases mentioned in Section 5 of PD 902-A was transferred to the Special Commercial Courts. (S5.2) Under Section 5(c) of PD 902-A, the SEC had jurisdiction over cases involving controversies in the election or appointments of directors, trustees, officers or managers of corporations, partnerships, or associations. Section 6(g) of PD 902-A also provides that in order to effectively exercise its jurisdiction under Section 5, the SEC shall possess the power to pass upon the validity of the issuance and use of proxies and voting trust agreements. The SEC’s power to pass upon the validity of proxies in relation to election controversies has effectively been withdrawn since such power is connected to its abrogated jurisdiction under Section 5. The power now pertains to the SCC in the exercise of its jurisdiction under S5.2. Proxy-solicitation issues in relation to election controversies also fall within the SCC’s jurisdiction because the issue of proxy solicitation and proxy validation are antecedent matters intimately related to such election controversy. Here the proxies were issued in relation to the election of the directors of Meralco. Hence the issue concerning their solicitation and validation falls within the original and exclusive jurisdiction of the SCC. The SEC however retains regulatory and investigatory powers over proxies under Sections 20 and 53 of the SRC if these are issued in connection with matters other than the election of directors, trustees, officers, and managers. (GSIS v CA, G.R. No. 183905, 16 April 2009; reiterated in SEC v. CA, 22 October 2014). Q Feeling aggrieved, National Life Insurance Company of the Philippines (NLICP), a minority shareholder corporation in Union Cement Corporation, filed a complaint with the SEC praying that the mandatory tender offer rule be applied to CEMCO. The SEC ruled in favor of NLICP by ordering CEMCO to make a tender offer for UCC shares to NLICP and other UCC shareholders. On appeal, CEMCO argues that while the SEC can take cognizance of NLICP’s complaint on the alleged violation by CEMCO of the tender offer rule under S19 of the SRC, the SRC does not vest the SEC with jurisdiction to determine and adjudicate the rights and obligations of the parties. CEMCO argues that under the SRC, the SEC’s authority is purely administrative; hence the SEC can only impose administrative sanctions but not grant affirmative relief. Is CEMCO’s argument correct? A No. In taking cognizance of NLICP’s complaint and eventually rendering a judgment ordering CEMCO to make a tender offer, the SEC was acting pursuant to Rule 19(13) of the Amended Implementing Rules and Regulations of the SRC which provides that upon complaint for a violation of the tender offer rule, the SEC may nullify the acquisition of shares and direct the holding of a tender offer. The basis for Rule 19(13) is Sec. 5.1(n) of the SRC which provides that the SEC may “[e]xercise such other powers as may be provided by law as well as those which may be implied from, or which are necessary or incidental to the carrying out of, the express powers granted the Commission to achieve the objectives and purposes of these laws.” (Cemco Holding Inc. v. National Life Insurance Co., G.R. No. 171815, 7 August 2007).

2016 Notes on the Securities Regulation Code by Prof. Manuel R. Riguera for Jurists Bar Review Center™. All rights reserved 2016 by Jurists Review Center Inc. Unauthorized reproduction, use, or dissemination is strictly prohibited and shall be prosecuted to the full extent of the law, including administrative complaints with the Office of the Bar Confidant, Supreme Court. Page 2 of 15

An intra-corporate and an election dispute (propriety of the election of a party as a director) involving a corporation under sequestration of the Presidential Commission on Good Government (PCGG) falls under the jurisdiction of the Regional Trial Court (RTC), not the Sandiganbayan. (Phil. Overseas Telecommunications Corp. v. Africa, G.R. No. 184622, 3 July 2013). Philcomsat’s complaint to make PCGG withdraw its objection to the listing in the PSE of PHC shares owned by Philcomsat relates to an intracorporate dispute within the jurisdiction of the Special Commercial Courts, since the Republic is an indirect owner of PHC. (Philippine Communications Satellite Corp. v. Sandiganbayan, 17 June 2015). SEC’s revocation of Universal Rightfield’s registration of securities and of its permit to sell securities is not an exercise of quasi-judicial but of regulatory power. Hence the strict due process requirement of a formal hearing is not required and due process is satisfied through letters giving UR a chance to explain why revocations should not ensue. (SEC v. Universal Rightfield Property Holdings, 20 July 2015). CONCEPT OF SECURITIES -

A security is an interest in a commercial enterprise or profit-making venture and evidenced by an instrument, whether written or electronic in character. (S3.1). The main feature of a security is that a person purchases or acquires the same in the expectation of obtaining passive income or asset appreciation, that is income or gain obtained through the effort of another person. This feature makes them attractive and desirable and necessitates the protection of the investing public. Howey Test

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Investment contracts are defined under the Implementing Rules and Regulations of the SRC as “a contract, transaction, or scheme whereby a person invests his money in a common enterprise and is led to expect profits primarily from the efforts of others.” (Italics supplied). What is the Howey test? It is a test to determine an investment contract: “a contract whereby a person invests his money in a common enterprise and is led to expect profits solely from the efforts of others.” (ICES). In SEC v. W.J. Howey Co., 328 US 293 (1946), a company selling orange groves with accompanying service contracts for the buyers wherein the produce would be pooled and the profits allocated to the buyers, was held to be selling investment contracts. In the Philippines, we follow a flexible or modified Howey test which replaces the word “solely” with “primarily.” (ICEP) A real estate marketing company entertains applications for so-called “Business Center Owners (BCOs), whereby the BCOs would buy realty from accredited developers for $234 and then be entitled to a referral bonus of $92 if they referred other applicants for BCOs. The BCOs would also be entitled to referral bonus from the recruits obtained by their referrals and so on down the line. The SC upheld the SEC’s finding that the scheme was an investment contract. The SC rejected the argument that the scheme was merely leveraged marketing and held that the applicant was led to expect profits primarily from the efforts of his recruits. (Power Homes Unltd. Corp. v. SEC, G.R. No. 164182, 26 February 2008). (Asked 2010 Bar). Sale by Prosperity.com of websites to first-time buyers, with the latter earning commissions from Prosperity.com if they refer their own “down-line buyers” not an investment contract but network marketing. Last element in Howey Test not present. (SEC v. Prosperity.com, 25 January 2012). An arguable ruling.

2016 Notes on the Securities Regulation Code by Prof. Manuel R. Riguera for Jurists Bar Review Center™. All rights reserved 2016 by Jurists Review Center Inc. Unauthorized reproduction, use, or dissemination is strictly prohibited and shall be prosecuted to the full extent of the law, including administrative complaints with the Office of the Bar Confidant, Supreme Court. Page 3 of 15

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PDCs and “certificates of management” issued by Mateo Group and Tibayan Group are securities since the holders expect to gain from the increase in value of the same or from payment of interest or yield. PDCs issued by ASB Holdings Inc. to lenders may fall under “evidences of indebtedness” in RSA (SRC). The DOJ Resolution makes out a prima facie case for violation of the RSA provision requiring registration of securities. The CA should not have ordered the dismissal of the criminal cases for violation of Sec. 4 in relation to Sec. 56 of the RSA. (Gabionza v. CA, G.R. No. 161057, 12 September 2008). “Time-Share” contracts for occupancy of certain bungalows for a definite time and place are securities. The people buying the same anticipate the increase in value thereof and expect to profit from their resale. “Securitization” refers to the process of converting certain types of assets or income into securities form. In the United States, banks and finance companies aggressively lent to the so-called “sub-prime” borrowers. The mortgages issued by the borrowers were packaged into so-called collateralized mortgage obligations (CMOs) and sold to investors, including big investment banks like Bear Stearns and Citibank. When the borrowers could no longer pay the stiff interest rates, their cascading defaults resulted to the subprime crisis in August 2007.

BASIC TYPES OF SECURITIES 1. Equity security. Shares of stock in corporations. Gain is through dividends and asset appreciation. 2. Debt security. Promissory notes, commercial paper, bonds. Where there is a promise of payment of the principal and interest. Gain is through interest and asset appreciation. 3. Derivatives. Options and warrants. Financial instruments whose value depends on an underlying security but which does not require any investment of principal in the underlying security. REGULATORY THRUST OF THE SRC -

Registration of Securities Reportorial Requirements. Registration & Regulation of Securities Professionals. Regulation of Exchanges. Stiff sanctions and penalties on securities fraud and violations.

REGISTRATION OF SECURITIES - Purpose: To protect the investing public by subjecting the securities to disclosure and reportorial requirements. The SEC may even audit the FS of the firm applying for registration of its securities. - The SEC does not guarantee the soundness of registered securities. Registration does not guarantee the soundness of the securities. Caveat emptor still applies but the investor is now better guided in making his decision. EXEMPT SECURITIES (9.1) BRIG 1. Government issued or guaranteed securities. Includes foreign government under 9.2. 2. Receiver or trustee in bankruptcy issued certificates. 3. IC, HLURB, and BIR supervised and regulated securities.

2016 Notes on the Securities Regulation Code by Prof. Manuel R. Riguera for Jurists Bar Review Center™. All rights reserved 2016 by Jurists Review Center Inc. Unauthorized reproduction, use, or dissemination is strictly prohibited and shall be prosecuted to the full extent of the law, including administrative complaints with the Office of the Bar Confidant, Supreme Court. Page 4 of 15

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Bank securities (note: except the bank’s own shares). SRC Rule 9.2 provides that evidences of indebtedness issued by a quasi-bank are also exempt from registration.

SEC may by regulation and after public hearing add to the foregoing list where registration of the security not necessary in the public interest and protection of investors. EXEMPT TRANSACTIONS (10.1).

JEMS SBC SPIEL

Automatic exemptions a) b) c) d) e) f) g) h) i) j) k) l)

Judicial & insolvency sale. Liquidation of security by lien-holder. Isolated transaction by owner. Stock dividend. Exclusive stockholders’ purchase. Mortgage-backed securities sold to single purchaser at single sale. Conversion. Broker’s transactions. Subscription (Pre-Incorporation or increase of authorized capital stock). Exchange of securities by issuer with stockholders exclusively. Private Placement (sale to fewer than 20 in any 12-month period). Sophisticated (financially) buyers. (BIRIPI)

Nestle Phils. Inc. v. CA, 203 SCRA 504 (1991). Issuance of shares out of previously authorized but un-issued capital stock not considered as an automatic exception under the RSA since the exemption only applies to issuance of shares as part of and in the process of increasing the authorized capital stock. Now may be covered under S10.1(k) or (e) of the SRC. Application for exemptive relief (10.2) SEC may exempt other transactions where not necessary in public interest or for protection of investors such as small amount or limited character of public offering. Exemption fee to be paid. (10.2). An exemption fee of 1/10 of 1% of the maximum aggregate price or issued value of the securities should be paid. (10.3) REGISTRATION PROCEDURE IN A NUTSHELL. F (ses) POP SC 1. Filing of sworn registration statement containing the information as the SEC may by rule require. a) Signatories to registration statement: Executive officer, principal operating officer, principal financial officer, comptroller, principal accounting officer, corporate secretary. (FOE CAC) b) Expert’s written consent. Written consent of the expert named as having certified any part of the registration statement. c) Certification by selling stockholders. Where the registration statement includes shares to be sold by selling shareholders, a written certification by such selling shareholders as to the accuracy of any part of the registration statement contributed to by such selling shareholders shall also be filed. 2. PUBLICATION of notice of the filing of the registration statement (1 x 2) in two NGC. 3. ORDER declaring the registration statement effective or rejecting it.

2016 Notes on the Securities Regulation Code by Prof. Manuel R. Riguera for Jurists Bar Review Center™. All rights reserved 2016 by Jurists Review Center Inc. Unauthorized reproduction, use, or dissemination is strictly prohibited and shall be prosecuted to the full extent of the law, including administrative complaints with the Office of the Bar Confidant, Supreme Court. Page 5 of 15

4. PROSPECTUS under oath that all requirements satisfied and all statements in RS and in prospectus correct. 5. SALE of Securities. 6. Notice of Offering COMPLETION/Termination. The SEC may suspend the offer and sale of securities pending any investigation for the purpose of revoking the registration statement. The suspension order shall be confidential and shall not be published but shall nonetheless be binding upon the persons notified. Any sale in violation of the suspension order shall be void. (S13.4). REGISTRATION & REGULATION OF SECURITIES PROFESSIONALS No person shall engage in the business of buying or selling securities in the Philippines as a broker or dealer, or act as a salesman, or an associated person of any broker or dealer unless registered as such with the SEC. (S28.1) An “information provider” who was instrumental in the sale of securities is considered as a broker even if she did not sign in the relevant documents. Not being registered as a broker with the SEC, she could be charged with the violation of Sec. 28.1. (SEC v. Santos, G.R. 195542, 19 March 2014) REPORTORIAL REQUIRMENTS -

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At end of fiscal year annual report - Balance Sheet, Profit and Loss Statement, Statement of Cash Flows. (17.1.a) The reportorial requirements shall apply to an issuer which has sold registered securities, with listed shares, with assets of at least P50 million and having 200 or more holders each holder holding at least 100 shares. (17.2) In any case wherein the issuer satisfies the requirements of S17.2, any person who acquires the beneficial ownership of > 5% of equity shares shall submit a disclosure statement to the issuer, the commission, and the exchange (ICE). The purpose is to alert the shareholders and the issuer of a possible take-over or tender offer and to discourage “creeping” take-over. Philippine Veterans Bank a public company under S17.2(c), even though its shares are available only to a limited class or sector. (Philippine Veterans Bank v. Callangan, 3 August 2011).

PROTECTION OF SHAREHOLDER INTERESTS TENDER OFFERS (S19). A tender offer is an offer by a person or group of persons to the stockholders of a corporation to tender their shares for purchase by the offeror. Usually the tender offer is subject to a minimum or maximum that will be purchased. The aim is to get a sizable block of shares in order to get control of a company. It is usually employed as a takeover device where the controlling shareholders refuse to sell out in a friendly negotiated sale. Mandatory tender offer rule The rule on tender offers seek to protect minority shareholders who might get left out if the tender offeror only deals with the holder of sizable blocks of shares. The shares of the minority stockholders would be diluted and if they want to sell, the acquirer would just quote them a cheaper price. The mandatory tender offer rule requires the offeror to make a

2016 Notes on the Securities Regulation Code by Prof. Manuel R. Riguera for Jurists Bar Review Center™. All rights reserved 2016 by Jurists Review Center Inc. Unauthorized reproduction, use, or dissemination is strictly prohibited and shall be prosecuted to the full extent of the law, including administrative complaints with the Office of the Bar Confidant, Supreme Court. Page 6 of 15

tender offer not just to those with sizable stockholdings but to all stockholders, including minority stockholders. Mandatory tender offer rules apply if the target is a: 1. Listed corporation, or 2. Corp with assets of at least P50M and having at least 200 stockholders with at least 100 shares each. A person or group of persons who intends to acquire at least 15% of the shares of such corporation or who intends to acquire at least 30% of the shares over a period of 12 months shall make a tender offer. -

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The offeror shall file a statement with SEC that it is making a tender offer. Securities deposited pursuant to a tender offer may be withdrawn by tenderer at any time tender offer remains open unless previously accepted for payment and at any time after 60 days from the date of the original tender offer. Where the securities deposited exceed the number tender offeror willing to take up, the same shall be accepted pro-rata. Varying terms by increasing consideration. Tender offeror shall pay the increased consideration to those whose shares earlier taken up and paid for. To prevent unfairness to those who tendered earlier.

Pursuant to Sec. 72.1 of the SRC, the SEC by regulation increased the threshold percentage to 35%. (SRC Rule 19, Par. 2; Rafael Morales, the Securities Regulation Code Annotated 156 [2005]). Under existing SEC Rules, the 15% and 30% threshold acquisition of shares was increased to 35%. It is further provided that mandatory tender offer is still applicable even if the acquisition is less than 35% when the purchase would result in ownership of over 51% of the total outstanding equity securities of the public company. (Cemco Holding Inc. v. National Life Insurance Co., G.R. No. 171815, 7 August 2007). Q Union Cement Corporation (UCC), a corporation listed with the PSE, has two principal stockholder corporations, UCHC which owns 60% of UCC shares, and CEMCO which owns 17% of UCC shares. In turn the principal stockholders of UCHC with their respective share ownership percentages are the following corporations: BCI (21%), ACC (30%), and CEMCO (9%). BCI and ACC passed resolutions agreeing to sell their UCHC shareholdings to CEMCO. In response to a PSE letter, the SEC en banc resolved that the CEMCO transaction was not covered by the tender offer rule. The CEMCO transaction was consummated by the parties. Since CEMCO owns 60% of UCHC shares, and since UCHC owns 60% of UCC shares, the result was that CEMCO had 36% indirect ownership of UCC. Adding the 36% indirect ownership to CEMCO’s 17% direct ownership, CEMCO would have a total of 53% beneficial ownership of UCC shares. Feeling aggrieved, National Life Insurance Company of the Philippines (NLICP), a minority shareholder corporation in UCC, filed a complaint with the SEC asking the SEC to reverse its en banc resolution and praying that the mandatory tender offer rule be applied to CEMCO. The SEC ruled in favor of NLICP by reversing its earlier resolution and ordering CEMCO to make a tender offer for UCC shares to NLICP and other UCC shareholders. CEMCO argues that the tender offer rule applies only to direct acquisition of shares of the target company. Is CEMCO’s argument correct? A No. The SEC’s interpretation that the tender offer rule applies to both direct and indirect acquisition has to be accorded respect as it is made by a specialized agency. The purpose of the tender offer rule is to protect the minority stockholders against the dilution 2016 Notes on the Securities Regulation Code by Prof. Manuel R. Riguera for Jurists Bar Review Center™. All rights reserved 2016 by Jurists Review Center Inc. Unauthorized reproduction, use, or dissemination is strictly prohibited and shall be prosecuted to the full extent of the law, including administrative complaints with the Office of the Bar Confidant, Supreme Court. Page 7 of 15

of the value of their shares. The danger of dilution is present in both direct and indirect acquisitions. (CEMCO Holdings, Inc. v. National Life Insurance Company of the Philippines, G.R. No. 171815, 7 August 2007). (Asked 2010 Bar). PROXY SOLICITATIONS (20) - No broker or dealer shall give any proxy or authorization in respect of any security carried for the account of a customer to a person other than the customer without the express written authorization of such customer. - A broker or dealer who holds the proxy of at least 10% of the outstanding shares of the issuer shall submit report to the issuer, the Commission, and the exchange (ICE) identifying the beneficial owner. PROHIBITIONS ON FRAUD, MANIPULATION, & INSIDER TRADING 1. WASH SALE. Transactions involving no change in beneficial ownership. 2. MATCHED ORDER. Entering an order for sale or purchase with knowledge that matching order for purchase or sale at substantially the same price, time, and size. Purpose of 1 & 2 is to create false impression of trading and jack up price of security. 3. MARKING THE CLOSE. The buying and selling of securities at the close of the market in an effort to manipulate the closing price of such securities. 4. HYPE AND DUMP. Engaging in buying activity at increasingly higher prices and then selling securities in the market at the higher prices. 5. BOILER ROOM OPERATIONS. Activities out of low-rent offices and which use high-pressure tactics (e.g., cold-calling or direct mail offers) typically involving the sale of dubious or unsound securities. 6. CHURNING. The excessive trading by a broker of the shares in his client’s account with a view not to benefit the client but to generate commissions for the broker. 7. SHORT-SALE. Sale of a security that was borrowed by the seller. 3 parties are involved: the seller, the buyer, and the securities lender. Illustration: S borrows 100 SMC shares from L repayable in 30 days. At that time SMC P1 per share but S expects the share price to fall within 30 days. S sells the 100 shares to B and gets P100. SMC shares fall to P0.50 per shares after 15 days. Using the sales proceeds, S buys from the market 100 SMC shares for P50 and repays L the 100 SMC shares he had borrowed plus interest of P5. S profits by P45 (P50 gain less P5 interest on the borrowed securities). Short-selling is not prohibited but only regulated. The SEC promulgated the Rules on Securities Borrowing and Lending effective 6 July 2006. 8. OPTION. An instrument which gives one the option to buy (call) or sell (put) a security. Options are also called derivatives since their value rests on the underlying security, the one subject of the option. 9. CALL OPTION. An option to buy a security from another person at a predetermined price within a fixed period. E.g. an option to buy from O 10,000 shares of SMC at P50 within a period of 30 days. A person may be in the business of selling call options. He does not want the price to increase. The person buying the call option wants the price to increase. 10. PUT OPTION. An option to sell a security to another person at a pre-determined price within a fixed period. E.g. an option to sell to O 10,000 SMC shares at P50 within a period of 30 days. A person may purchase put options if he anticipates SMC shares to depreciate or if he owns SMC shares and he wants to have a hedge or protection against SMC shares falling in value. 11. STRADDLE. An option to both buy and sell a security to another person at a predetermined price within a fixed period. E.g., an option to buy or sell SMC shares at P50 within a period of 30 days. Since the option buyer profits either way, the price

2016 Notes on the Securities Regulation Code by Prof. Manuel R. Riguera for Jurists Bar Review Center™. All rights reserved 2016 by Jurists Review Center Inc. Unauthorized reproduction, use, or dissemination is strictly prohibited and shall be prosecuted to the full extent of the law, including administrative complaints with the Office of the Bar Confidant, Supreme Court. Page 8 of 15

of the straddle is more that the put or call. If the stock does not move however, he will lose the amount he paid for the straddle. 12. WARRANT. A long-term call option on corporate shares out of unissued or treasury shares reserves. Options are not prohibited or illegal per se. However trading in them is subject to strict regulations because these are highly complex instruments (rocket science) and the possibility of the unsophisticated investor losing money on them is great. PSE members prohibited from directly or indirectly guaranteeing the performance of any option on a registered security. (S25) Purpose is to prevent bankruptcy of the PSE members. A registered warrant is however not covered by the prohibition in S25. TRANSACTIONS OF DIRECTORS, OFFICERS, & PRINCIPAL STOCKHOLDERS (23) -

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Directors, officers, and stockholders who are beneficial owners of > 10% of the shares of a corporation which has sold registered shares, listed, or with assets of P50 million and 200 or more holders holding at least 100 shares each shall file report with SEC and PSE (if listed) indicating their ownership and the monthly report re ownership and change of ownership in shares they are holding in the corporation. Purpose is to monitor insider trading. Also for the information of investors and analysts. SHORT-SWING PROFIT: Profit from selling a security obtained within a period of 6 months from the purchase of the security. Any profit obtained by a DOS within a 6-month period from the sale of shares of a corporation of which he is a DOS shall inure to and be recoverable by the issuer. Suit may be filed by the issuer or a holder of security in such issuer for and in behalf of the issuer. The DOS cannot sell a share of issuer which he does not own or owning it does not deliver within 20 days. Aim is to prevent DOS from short-selling. No problem if he sells his own shares.

INSIDER TRADING. Purpose: The SRC provisions punishing insider trading seek to prevent unfairness to the investing public since the insider is profiting from material information not available to the public. MATERIAL NON-PUBLIC INFORMATION (MNI). Material information about the security or the issuer that is not generally available to the public. Information is material when it will affect the price of the security or would influence a person in deciding whether to buy, sell, or hold a security. Who are considered as insider? (See S3.8) TRIGOD 1. The issuer. [I] 2. A director or officer of the issuer or a person controlling the issuer. [DO] 3. A person whose relationship or former relationship to the issuer gives or gave him access to MNI. [R] 4. A government employee, or director, or officer (G-O-D) of an exchange, clearing agency, and/or self-regulatory organization (S-E-C) who has access to MNI. [G]

2016 Notes on the Securities Regulation Code by Prof. Manuel R. Riguera for Jurists Bar Review Center™. All rights reserved 2016 by Jurists Review Center Inc. Unauthorized reproduction, use, or dissemination is strictly prohibited and shall be prosecuted to the full extent of the law, including administrative complaints with the Office of the Bar Confidant, Supreme Court. Page 9 of 15

5. A person who learns such information by a communication from any of the foregoing insiders. [T] In securities parlance this person is called a “tippee.” The tippee must know that the tipper is an insider. (S30[b] RSA). G.R. Insider cannot buy or sell a security while in possession of material non-public information re the security or issuer. Unless: 1.

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Insider proves that the information was not gained by virtue of being an insider or from an insider. For instance he may prove that he obtained the information from security analysts who follow the company’s stock; or The counterparty is identified and the insider proves that he disclosed the information to the counterparty or that he has good reason to believe that the counterparty is in possession of the info. (Sec. 27, SRC).

Q Grand Gas Corporation, a publicly listed company, discovered after extensive drilling a rich deposit of natural gas along the coast of Antique. For five months, the company did not disclose the discovery so that it could quietly and cheaply acquire neighboring land and secure mining rights to the land. Between the discovery and its disclosure of the information to the Securities and Exchange Commission, all the directors and key officers of the company bought shares in the company at very low prices. After the disclosure, the price of the shares went up. The directors and officers sold their shares at huge profits. a) What provision of the Securities Regulation Code (SRC) did they violate, if any? b) Assuming that the employees of the establishment handling the printing work of Grand Gas Corporation saw the exploration reports which were mistakenly sent to their establishment together with other materials to be printed. They too bought shares in the company at low prices and later sold them at huge profits. Will they be liable for the violation of the SRC? (08 Merc Bar Q13). A a) The directors and officers violated the SRC provisions on insider trading. Under the SRC, directors and officers who trade shares of their corporation while in possession of material non-public information are liable for insider trading. Here the directors and officers were in possession of non-public information that Grand Gas had discovered a rich natural gas deposit and such information was material since it would boost the share price of Grand Gas. Hence the directors and officers are liable for insider trading. (Sec. 27, SRC; SEC v. Texas Gas Sulphur Co., 401 F.2d. 833). b) No the printing establishment’s employees are not liable for insider trading. Under the SRC, in order for one to be liable for insider trading, he must first of all be an insider. The employees are not within the purview of Sec. 3.8(c) since their relationship as employees of the print shop handling the printing work of Grand Gas did not give them access to material non-public information. The employees were not fiduciaries. They were not intended to have access to MNI as shown by the fact that the exploration reports were mistakenly sent to them. It was not their relationship but the erroneous sending of the exploration reports which gave them access to MNI. Nor are they insiders under Sec. 3.8(e) as they did not learn of the MNI by a communication but by an inadvertent error. Hence the employees cannot be held liable for insider trading. (Chiarella v. United States, 445 U.S. 222 [1980]). Q Andy, a lawyer working with Bigfoot Mining Corporation, whose shares are listed in the Philippine Stock Exchange, is aware that the DENR will close down BMC’s Samar mine for violation of environmental laws. This information is not yet known to the public. He discloses the information to his friend Pedro, who knows that Andy is a lawyer working with

2016 Notes on the Securities Regulation Code by Prof. Manuel R. Riguera for Jurists Bar Review Center™. All rights reserved 2016 by Jurists Review Center Inc. Unauthorized reproduction, use, or dissemination is strictly prohibited and shall be prosecuted to the full extent of the law, including administrative complaints with the Office of the Bar Confidant, Supreme Court. Page 10 of 15

BMC on sensitive matters. Pedro discloses the information to his mistress Jana who is aware of the nature of the information and how Pedro came across it. a) Andy, Pedro, and Jana all sell shares of BMC prior to the announcement by the DENR that it will close the Samar mine. Are Andy, Pedro, and Jana liable for insider trading? Andy is liable since his relationship as lawyer gave his access to MNPI. Pedro is a tippee and thus is an insider who is liable for insider trading. Jana is not liable since she is not an insider. She did not learn her communication from the insiders mentioned in S3.8(1)(2) and (3) and (4) but from a tippee. b) Would Andy be liable if he did not sell shares of BMC? Yes it is unlawful for an insider to disclose MNI to another person who by virtue of the communication becomes an insider if the insider knows that the other person will likely buy or sell a security of the issuer while in possession of such information. (27.3). By virtue of Andy’s communication to Pedro, the latter became a tippee or an insider and likely to trade on such information. It is immaterial whether Pedro actually buys or sells BMC shares. c) Would Pedro be liable for his disclosure even if he does not sell BMC shares? No. While Pedro himself is an insider or tippee, Jana herself did not become an insider by virtue of Pedro’s communication. Hence Pedro would not be liable for the violation of S27.3. In determining whether a tippee is under an obligation to disclose or abstain from disclosure, it is necessary to determine whether the insider’s tip constituted a breach of his duty and the test for that is whether the insider will personally benefit from his disclosure. Where the insiders were motivated by a desire to expose fraud, there was no breach of fiduciary duty and thus no derivative breach by Dirks, a New York securities analyst. (Dirks v SEC, 463 US 646 [1983]). PRESUMPTION (SCIENTER). A purchase or sale by an insider or the insider’s spouse or R2 (legitimate or common-law) shall be presumed to have been effected while in possession of MNI if transacted after such info came into existence but before public dissemination and the lapse of a reasonable time for the market to absorb (digest) such information. Note that under the Securities Regulation Code, the standard is “knowing possession” of MNI, not the use thereof. For instance if a corporate officer gets to possess MNI regarding his company’s shares, he cannot buy the shares even if he already had been following a predetermined plan of purchasing 100 shares of the company every month. What he should do is to refrain from trading or to disclose the MNI to the counterparty. SPECIAL RULE RE TENDER OFFERS Tender offers or intended tender offers usually result in increase of price of shares of target corporation. Unlawful for a person other than the tender offeror who has MNI relating to such tender offer to buy or sell securities of the target corporation if he knows or has reason to believe that the info is non-public and has been acquired directly or indirectly from the tender offeror, those acting on its behalf, the target corporation or an insider of such target corporation. (S27.4[a][i]. The person need not be an insider just so long has he knows or has reason to believe that the info is non-public and has been acquired from the tender offeror, etc. Hence if a tender offeror mistakenly sends the tender-offer documents to its printer, then the printer will be liable if he buys shares of the target corporation. 2016 Notes on the Securities Regulation Code by Prof. Manuel R. Riguera for Jurists Bar Review Center™. All rights reserved 2016 by Jurists Review Center Inc. Unauthorized reproduction, use, or dissemination is strictly prohibited and shall be prosecuted to the full extent of the law, including administrative complaints with the Office of the Bar Confidant, Supreme Court. Page 11 of 15

Likewise the tender-offeror, the issuer, and an insider cannot communicate MNI to other persons if the communication is likely to result in such person buying or selling the securities of the target corporation. Q Ms. OB was employed in MAS Investment Bank. WIC, a medical drug company, retained the Bank to assess whether it is desirable to make a tender offer for DOP Company, a drug manufacturer. OB overheard in the course of her work the plans of WIC. By herself and thru associates, she purchased DOP stocks available at the stock exchange priced at P20 per share. When WIC’s tender offer was announced, DOP stocks jumped to P30 per share. Thus OB earned a sizable profit. Is OB liable for breach and misuse of confidential or insider information gained from her employment? Is she also liable for damages to sellers or buyers with whom she traded? If so, what is the measure of such damages? Explain briefly. (04 Bar Q2). A

Yes OB is liable for breach and misuse of confidential or insider information. Under S27.4(a)(i) of the SRC, it shall be unlawful where a tender offer has commenced or is about to commence for any person (other than the tender offeror) who is in possession of MNI relating to such tender offer, to buy or sell securities of the target corporation if such person knows or has reason to believe that the information is nonpublic and has been acquired directly or indirectly from the tender offeror, those acting on its behalf, the issuer of the securities sought or to be sought, or any insider of such issuer. Yes OB is liable for damages to sellers or buyers with whom she traded. Under S63 in relation to S61, the court is authorized to award damages in triple the amount of the transaction plus actual damages. The court may also award exemplary damages and attorney’s fees not exceeding 30% of the award. (Note: The facts of the problem appear to indicate that OB is not an insider as she “overheard” the plans of WIC. Hence the nature of her work at MAS did not give her access to MNI. Nonetheless she is still liable under S27.4(a)(i) which applies to tender offer and which does not require that the person trading the securities of the target corporation be an insider.). EXCHANGES & OTHER SECURITIES MARKETS Market is an amorphous concept. Essentially it is the situation wherein there is a regularity and frequency of trades in securities or class of securities, a situation which allows a person to buy a security or sell securities he is holding with relative ease or what is called liquidity. This is the main function of a market, to provide liquidity. Also as a means of raising capital or funds as alternative to expensive bank financing.

UNCERTIFICATED SECURITIES Uncertificated security is a security evidenced by electronic or similar (e.g. optical) records. (S3.14) Trend is toward paperless or scripless, rather than paper-based, securities and transactions. A corporation whose shares are registered with SEC or listed with an exchange may issue uncertificated shares: The articles and by-laws of a corporation may provide that it issue shares in the form of uncertificated securities and subject to the condition that the shareholder may not require the corporation to issue a certificate in respect of any shares recorded in their name. So if you’re drafting articles and by-laws, make sure to include this provision.

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If no such provision, the corporation may still issue an uncertificated security if the board so resolves and the shareholder, investor, or securities intermediary agrees. TRANSFER & PLEDGE OF SECURITIES Transfer of Securities (S43.3). Transfer of securities, including uncertificated securities, may be validly made and consummated by appropriate book-entries in the: 1. 2.

Securities accounts maintained by securities intermediaries; or Stock and transfer book held by the corporation or the stock transfer agent.

Such book-keeping entries shall be binding on the parties to the transfer. Such transfer has the effect of delivery of a security in bearer form or duly indorsed in blank resulting in the unrestricted negotiability of the security. This affects Sec. 63 of the Corporation Code.

Also Sec. 30 of the NIL.

Transfer of uncertificated shares shall only be valid insofar as the corporation is concerned if the transfer is recorded in the corporate books so as to show the names of the parties and the number of shares transferred. (43.3). Pledge of Securities (S45) May be made if the securities intermediary indicates by book-entry that the security has been credited to a specially designated pledge account in favor of the pledgee. Considered delivered and indorsed to the creditor within the terms of Articles 2093 and 2095 of the Civil Code. Scripless transaction not binding on corporation however until the corporate secretary is duly notified. Cf paper-based pledge of certificate which is binding on corporation even if not recorded with the corporate books. MARGIN & CREDIT (S48) A person buys shares on credit. The amount he puts up is called equity while the amount he borrows is called the margin. Securities firms usually lend money to their customers to make purchases. Such lending is subject to the limits set forth in S48. -

65% of the current market price of the security. 100% of the lowest market price of the security during the preceding 36 months but not more than 75% of the current market price.

LEVERAGE. Using borrowed money to purchase securities. Leverage increases the margin of profit but also magnifies any loss. That is why margin trading is regulated, in order to avoid bankruptcies by investors who purchased shares on substantial margin. Margin trading led to appalling loses in Wall Street in the 1930s and brought about the Great Depression. PROSECUTION OF OFFENSES (S53) Q Petitioner was the former head of the HR department of Standard Chartered Bank (SCB). He bought the so-called “Global Third Party Mutual Funds (GTPMF) from SCB 2016 Notes on the Securities Regulation Code by Prof. Manuel R. Riguera for Jurists Bar Review Center™. All rights reserved 2016 by Jurists Review Center Inc. Unauthorized reproduction, use, or dissemination is strictly prohibited and shall be prosecuted to the full extent of the law, including administrative complaints with the Office of the Bar Confidant, Supreme Court. Page 13 of 15

wherein he invested US$8,000. His investment however depreciated to US$3,000. Subsequently Petitioner learned that SCB had offered for sale and sold the GTPMF without registering the same first as securities with the SEC. Petitioner then filed with the DOJ a complaint for violation of Section 8.1 of the SRC. The DOJ dismissed the petitioner’s complaint holding that it should have been filed with the SEC. Was the dismissal correct? A Yes. Under Sec. 53.1 of the SRC, a criminal complaint for violation of any law or rule administered by the SEC must first be filed with it. If the SEC finds that there is probable cause, then it should refer the case to the DOJ. A criminal charge for the violation of the SRC is a specialized dispute. Hence it must first be referred to an administrative agency of special competence, i.e., the SEC. Under the doctrine of primary jurisdiction, court will not determine a controversy involving a question within the jurisdiction of the administrative tribunal, where the question demands the exercise of sound administrative discretion requiring the specialized knowledge and expertise of said administrative tribunal to determine technical and intricate matters of fact. (Baviera v. Paglinawan, G.R. No. 168380, 8 February 2007). The Baviera ruling and Sec. 53.1 apply only to a criminal complaint and not to a civil action for declaration of nullity of contract and damages which alleges that unregistered securities were sold to the plaintiff. Under Sec. 63 of the SRC, the RTC has jurisdiction over all suits to recover damages under Secs. 56-61 of the SRC. (Pua v. Citibank, G.R. 180064, 16 September 2013). CIVIL LIABILITIES ON ACCOUNT OF FALSE REGISTRATION (S56) Any person who acquires a security, the registration statement of which contains an untrue statement of a material fact or omits to state a material fact, and who suffers damage may sue and recover damages from the following persons, unless it is proved that at the time of such acquisition, he knew of such untrue statement or omission: (ISDA PUPS) (a) The ISSUER and every person who SIGNED the registration statement. (b) The DIRECTOR of or PARTNER in the issuer or every person named in the registration statement as being or about to become a director of or partner in the issuer. (c) AUDITOR or AUDITING FIRM who/which certified any FS used in connection with the registration statement. (d) Any person who PREPARED or certified any part of the registration statement or a report or valuation used in connection with the registration statement. (e) SELLING SHAREHOLDER who contributed to and certified to the accuracy of a portion of the registration statement. (f) The UNDERWRITER of the security. CEASE AND DESIST ORDER (CDO) (S64) The SEC, after proper investigation or verification, motu proprio, or upon verified complaint by any aggrieved party, may issue a CDO without the necessity of a prior hearing if in its judgment the act or practice, unless restrained, will operate as a fraud on investors or is otherwise likely to cause grave or irreparable injury or prejudice to the investing public. (FG). Q Performance Foreign Exchange Corporation (PFC) is a domestic corporation whose primary purpose is to act as broker/agent between participants in the foreign exchange transactions. After two years of operation, PFC received a letter from the SEC requiring it to appear before the compliance and enforcement division (CED) for a clarificatory conference regarding its business operations. PFC’s officers complied and explained the 2016 Notes on the Securities Regulation Code by Prof. Manuel R. Riguera for Jurists Bar Review Center™. All rights reserved 2016 by Jurists Review Center Inc. Unauthorized reproduction, use, or dissemination is strictly prohibited and shall be prosecuted to the full extent of the law, including administrative complaints with the Office of the Bar Confidant, Supreme Court. Page 14 of 15

nature of their business before the CED. Subsequently the SEC issued a CDO against PFC stating that after inquiry, it has determined that PFC is engaged in the trading of foreign currency futures contracts in behalf of its clients without the necessary license and that the CDO is necessary to protect the investing public. PFC moved for the lifting of the CDO on the ground that it is not engaged in the trading of foreign currency futures and that what it was engaged in is spot currency trading. The SEC then sent a letter to the BSP requesting a definitive statement that PFC’s business transactions are a form of financial derivatives and thus can be performed only by banks and quasi-banks. Pending the BSP’s reply, the SEC denied PFC’s motion to lift the CDO and issued an order making the CDO permanent. PFC went to the CA via a petition for certiorari to annul the CDO issued by the SEC. Will PFC’s petition prosper? A Yes. Under S64 of the SRC it is required that a CDO issue only after proper investigation or verification. Here the clarificatory conference before the CED cannot be considered a proper investigation or verification since it was only a preliminary step as shown by the fact that the SEC had to request a definitive statement from the BSP regarding the nature of PFC’s business transactions. (SEC v Performance Foreign Exchange Corporation, G.R. No. 154131, 20 July 2006). SUBSTITUTED SERVICE UPON THE SEC (S65) Service of summons or other legal process shall be made upon the SEC in actions or legal proceedings against an issuer or any person liable under the SRC who is not domiciled in the Philippines. Upon receipt by the SEC of such summons, the SEC shall within 10 days thereafter transmit by registered mail a copy of such summons and the complaint or other legal process to such issuer or person at his last known address or principal office. Such sending shall complete the service. WAIVER OF PROVISIONS OF SRC VOID. (S71) Any stipulation waiving compliance with any provision of the SRC or any rule or regulation thereunder or any rule of an exchange shall be void. Any contract made in violation of the SRC or any rule or regulation thereunder shall likewise be void. RULES & REGULATIONS, EFFECTIVITY (S72) The SRC is self-executory. Failure on the part of the SEC to issue rules and regulations shall not in any manner affect the self-executory nature of the SRC. REPEALING CLAUSE (S76) While S76 of the SRC provides that the RSA was repealed in its entirety, the repeal does not extinguish criminal liability under S8 (failure to register security), S30 (insider trading), and S36 (disclosure of >10% beneficial ownership). This is because these provisions in the RSA were reenacted in the SRC. (SEC v Interport Resources Corp., G.R. No. 135808, 6 October 2008). -oOo-

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