Corporation Law

Part II - Securities Regulation Code

Debt Securities
Form of borrowings
Borrowings
o Second main source of capital of a corporation
o Represented usually by promissory notes, bonds or debentures
Long term loans obtained by the corporation may be private
o Ex: one from a bank or other financial institution, usually evidenced by promissory notes
Sometimes with condition
o That such lending financial institution will have some represetation in the board of directors
o Procedure: to assign one share of stock to a designated representative of the lending firm,
share to be redeemed upon full repayment of the loan
o If there is no vacancy in the board at the time of the loan, the representative may sit as an
ex officio director, a mere observer without the right to vote
o Role of representative is to see to it that his institutions investment is protected from
mismanagement or unfavorable corporate policies
Bonds and debentures
Requisites for bonded indebtedness
o Prior approval of SEC
o Registration with SEC
o Vote of 2/3 of the outstanding capital stock
Incurred by issuing bonds which are offered to the public or to a specified group of lenders
These debt securitues are a series of instruments representing units of indebtedness and regarded
as one entire debt
Usually issued in bearer form but provision is often made for registration in the owners names
Bonds vs debentures
o Bonds
usually secured by a mortgage or pledge of corporate property
always governed by trust indenture between the corporation and a trustee (in law
represents all the different bondholders)
o Debentures
Issued on a general credit of the corporation
Not secured by any collateral not bonded indebtedness in the true sense no
need of approval of the stockholders, but still good policy if obtained
Bonds issued by a corporation shall be registered with the SEC
Earn interest
o May be quarterly, annually or semi-annually, depending on the terms
Creditor-investor: interest; stockholder: dividends
o Interest
must be paid by the corporation whether it makes profits or not
fixed charge which the corporation cannot avoid or postpone even in times of
business depression
o Dividends can be paid only if there are profits
Stockholder more advantageous than bondholder when corporation is prosperous
o Dividends may prove to be much more than the fixed rat of interest on the bonds
Both must be paid at the stipulated period
Stockholder has to wait for the dissolution of the corporation and liquidation of its assets, and even
then, recouping his investment depends on whether there are any assets left after paying all
creditors, bondholders included
When corporation becomes insolvent

Corporation Law
Part II - Securities Regulation Code

Compromise agreement is usually worked out whereby all classes of security holders,
whether of equity or deby, make some sacrifice, scaling down their interests in order to keep
the corporation in operation because it is worth more as a going concern

Convertible securities; stock options

Contract of the security holder may give him the privilege to exchange his class of securities with
another class
Conversion usually from senior security (bonds and preferred stocks) to common stocks
Contract specifies
o From and to which class it can be converted
o Ratio of conversion
o Period within which the privilege may be exercised
Stock option warrants
o Sometimes granted instead of conversion privilege
o Options to purchasestocks in the corporation at a specified price not lower than par,
exercisable by the grantee at any time within a specified period
o Sometimes given as incentive compensation to valuable executives and employees
Convertible securities are often redeemable
o But the conversion privilege continues after notice of redemption is given until the fixed date
for actual redemption
Securities require provisions against dilution of the conversion privilege through transactions like
stock dividends
o Provision should be made for a proportionate increase in the number of common shares into
which the security is convertible in the event of such transactions
No specified provision on the matter but SEC has issued rules as to stock options
o Approval required before granting of any stock option
o If granted to non-stockholders, and to directors, officers or managing groups
Required approval of Stockholders owning at least 2/3 of the outstanding capital
stock
o SEC determines the reasonableness of the stock option plan
Corporation should retain or authorize enough of the junior securities to meet the conversion or
stock option when exercised
Hybrid securities
Because preferred shares and bonds are created by contract, it is quite possible to create stock
which approximates the characteristics of debt securities
Example: income bond
o Interest is dependent on earnings and which may be senior to stocks but subordinate to
other indebtedness
No limit to the variety of combinations which a draftsman may adopt
Issue: whether such a hybrid security is truly a bond or just another kind of preferred stock
o Curcial for tax purposes
o Bond interest deductible by the corporation from its gross income in the determination of
its taxable net income
o Stock interest paid would be dividends and not deductible from corporate income for tax
purposes
o Tests
Is the corporation liable to pay back the investor at a fixed maturity date
Is interest payable unconditionally at definite intervals or is it dependent on earnings
Does the security rank at least equally with the claims of other creditors or is it
subordinate to them

Corporation Law
Part II - Securities Regulation Code

Trust indenture
Three parties in a bond issue
o Debtor-corporation
o Creditor-bondholder
o Trustee
Bond embodies the promise to pay
Trust indenture
o Executed between the corporation and a trustee as representative of all the bondholders
Bond makes reference to the indenture which the bondholder will not see
Usually contains the following
o Description of the property mortgaged
o Provisions for its care and maintenance
o Payment of taxes
o Amount authorized under the issue
o Conversion and redemption of privileges
o Conditions under which the mortgage may be released
o Duties of the trustee
o Conditions for default
o Remedies in case of suh default
Requirements under the Revised Securities Act
Secuties Act requires the registration of securities with the SEC before a corporation can offer them
for sale
Securities Act aimed mostly at widely-held corporations, specially those whose securities are traded
on the stock exchange
Securities
o Covers a wide range of contracts in the nature of investments
o Includes the following, as defined by law
Shares of stock
Bonds
Debentures
Investment contracts
Voting trust certificates
Commercial papers evidencing indebtedness of any person
Financial or non-financial entity, issued, transferred or in any manner conveyed to
another
Life plans
Pre-need plans
Pension plans
Joint venture contracts
Similar contracts or investments where there is no tangible return on investments but
an appreciation of capital as well as enjoyment of particular privilege or services
Purpose and History of Revised Securities Act
1930s mining boom
o brought speculation to securities
o promised huge returs on investments which later proved worthless
Blue Sky Law (Act 2581)
o Aimed against speculative schemes which have no more basis than a few feet of blue sky
o Inadequate and ineffective to protect investors from sly operators
Hence, there was an urgent need for a body or office technically manned and with sufficient
regulatory powers to safeguard the interests of the investing public and prevent a repetition of the
deplorable events in the 1930s

Corporation Law
Part II - Securities Regulation Code

Securities Act (CA 83)

o Created the Securities and Exchange Commission
o Essentially also a Blue Sky Law since its main purpose was to protect investors in their
transactions dealing with securities
o 45 years after inactment, law became inadequate to meet the problems which came with
the growth of business and industry
BP 178
o Introduced changes intended mainly to increase the protection theretofore afforded
investors in securities
o Revised Securities Act
Revised Securities Act
o 3 basic requirements
the registration of securities
the registration of dealers, brokers and salesmen who deal in these securities
the registration of stock exchanges
o SEC is empowered to regulate and supervise all trading activities on such exchanges as well
as to grant licenses for the operation of organizations whose activities are related to the
securities market
o Procedure for security to be offered for sale to the public
Registered with the SEC, Unless exempted
Purpose: to compel the issuers of securities to make full disclosure of all the
information relative to such securities so that a prospective investor may be
made aware of their potentials or merits before he makes his investments
Sworn registration statement filed by the issuer with the SEC
Must contain the following:
o Names of directors and chief officers of the corporation
o General character of the business
o Capitalization
o Capital structure
o Description of the different classes of shares
o Copy of their prospectus
o Financial statements together with te purpose for which the funds for
which the security offered are to be used
o Any promotio fees or commission to be paid for the sale of such
securities
o The names of all persons, if any, owning more than 10% of the
outstanding stock of the issuer as of a date 20 days prior to te filing of
the registration statement
o Copy of the security being registered
o Estimated net proceeds to be derived from the security to be offered
o Price at which the security is proposed to be offered to the public
Payment of required fee
Publication of the fact of such registration
Statement: that all papers relating thereto are open to inspection at the SEC
Made in two newspapers of general circulation once a week for two
consecutive weeks
SEC approves or rejects
Approves
o Enter an order making the registration effective
o Issue to the registrant a permit to sell or offer to sell the securities
named in the certificate, with terms and conditions it may impose

Corporation Law
Part II - Securities Regulation Code

Then order transmitted to the exchange where the securities may be

listed published once in a newspaper of general circulation within 10
days from its promulgation

Reject
o On grounds specified by law
On its face, the registration statement is incomplete or
inaccurate as to a material fact
Issuer is not solvent
Issuer has violated any provision of the SRC or SEC rules
Issuer engaged in fraudulent transactions
Issuer not of good repute
An officer, director or principal stockholder is disqualified to be
such
Issuer has failed to show that the sale of the security would not
work to the prejudice of the public interest or as fraud upon
prospective investors
effects of falsity in the registration statement
o registration may be revoked by the SEC
o any contract entered into by a person in reliance of such statement is void, and he has the
right to recover damages from the person responsible, provided the action is brought within
2 years after discovery of the facts constituting the cause of action and within 5 yeaes after
such cause of action accrued
o the person or persons responsible for the false statement are criminally liable for either fine
or imprisonment

Exempt securities and exempt transactions

a certificate of exemption from SEC still necessary
usually exempted
o when the amount involved in the offering is small
o offering is only to a limited number of persons
o SEC finds that registration is not necessary in the public interest and for the protection of
investors
o Those issued or guaranteed by the Philippine government or y a foreign government with
whom the Philippines has diplomatic relations
o Those issued by building and loan associations and similar institutions
o Issued by a receiver with approval of the court
o Insurance policy issued by an insurance corporation
o Pre-incorporation subscriptions to the shares of a proposed corporation
Provided that no commission or compensation is paid in connection with the sale, and
only to the extent of the minimum requirement for incorporation
o Isolated transfers (vs public offering)
o Those that involve persons like the issuers stockholders, who need no protection because
they know or are presumed to know the business and operations of the corporation
o Subscriptions like the following:
Distribution of stock dividends
Transfers in connection with a consolidation or merger of the corporations whose
securities are involved
The conversion of securities of the same issuer
Transfer to any bank, trust company, or to any corporation or to any broker or dealer
Brokers transactions executed upon customers orders
Registration of brokers, dealers, and salesmen
Sale of securities usually done through brokers and dealers, and through stock exchange

Corporation Law
Part II - Securities Regulation Code

Revised Securities Act requires all brokers, dealers and salesmen of securities to apply for
registration with the SEC
o Application approved only if SEC is satisfied that the applicant is of good repute and has
complied with the provisions of the Act
After approval, payment of fees
Bond required conditioned on faithful compliance
o To answer for damages
Any time that a registered dealer or broker should intend to offer any security for sale, he must
notify the SEC in writing
Registration valid for 1 year, renewable annually
Registration may be revoked
o Violation of any provision or SEC rules
o Material false statement in his application
o Guilty of fraud in the sale of securities
o Demonstrated his unworthiness to handle or deal in securities

Registration of stock exchange

Stock exchange definition
o Any organization or group of persons which provides or maintains a market place of facilities
for bringing together purchasers and sellers of securities
Member of an exchange
o Any person permitted to use the facilities of the exchange without the services of a broker or
without payment of a commission or fee or with the payment of a reduced fee
To use facilities of exchange must be registered with SEC
SEC may exempt registration
o If it finds no necessity for registration because of limited volume of transactions
SEC also has the power to fix the number, size and location of the operations of a stock exchange
Over-the counter transactions
o Transactions executed outside the exchange
o SEC regulates over-the counter-markets, but not over-the-counter transactions
Prohibited devices
o Enumerated in Securities Act, Secs. 26 and 27
o Has a catch-all provision intended to cover any and all manipulative devices which the
ingenuity of brokers and dealers may employ in the future
Violation
o Imprisonment of not less than 7 tears nor more than 21 years
o Or a fine of not less than Php 5,000.00 but not more than Php 500,000.00
o Or both fine and imprisonment
o If corporation, imposed on guilty officers
Remedies of investor; SEC powers
Remedies
o Annulment of his contract provided the action is brought within 2 years from said contract
Contract void only as to the guilty party and any one who acquires rights thereunder with
knowledge of the violation
Damages charged upon the bond of the guilty dealer
SEC powers
o To establish of facilitate the establishment of trust funds which shall be contributed by
exchanges, brokers, dealers, underwriters, salesmen and other persons transacting in
securities, for the purpose of compensating investors for extraordinary losses
o Revoke registration of any security
Issuer becomes insolvent
Violated any provision

Corporation Law
Part II - Securities Regulation Code

o
o

Fraudulent transactions
Dishonest
Fraudulent misrepresentation
Does not conduct business in accordance with law
Suspend trading in any registered security on any exchange for not more than 30 days or,
with the approval of the President, for as long as 90 days
Impose administrative sanctions for any violation of its provisions or of SEC rules and orders
Disqualification from being officer, member of the board of directors or principal
stockholder
Fine of no less than Php 200 nor more than Php 50,000.00 plus not more than Php
500.00 for each day of continuing violation
Without prejudice to criminal charges
Cease and desist orders
Even without hearing if imminent grave injury

Underwriting Securities
How securities, both equity and debt, may be sold with the highest probability of obtaining the
capital resources needed by the corporation
Close corporations
o Stockholders who want to keep the corporation close will ordinarily furnish the capital
themselves or negotiate for a bank loan
Underwriting
o Usually when securities issued are intended to be sold publicly
o Definition an act or process of guaranteeing the distribution and sale of securities of any
kind iissued by another corporation
o Types (not exclusive)
Strict underwriting method
The underwriter agrees, for a fee or premium, to sell the securities to the
public and take up whatever portion of the issue is not sold within a specified
period
Underwriter often protects himself by agreements with sub-underwriters to
which the issuers of the security (corporation) is not a party
Firm commitment underwriting
Assuers the issuer of a specified amount of money at a certain time and shifts
the risk of the market to the investment houses
Issuer sells the entire issue outright to a group of securities firms, represented
by one or several managers or principal underwriters, who in turn sell at a
price differential to a larger selling group of dealers, and the latter will sell at
another differential to the public
Issuer manufacturer
Members of the underwriting group wholesalers
Members of the selling group retailers
Securities of particular issuers are not distributed continually but once in a
long time, but usually in a large batch
Best efforts underwriting
Availed of by corporations which are not yet well established and therefore
find it difficult to find an underwriter who will give a firm commitment and
assume the risk of distribution
They have to be content to distribute their securities through firms which
merely undertake to use their best efforts to sell the securities
Not underwriting in the true sense

Corporation Law
Part II - Securities Regulation Code

The investment house, instead of buying the issue from the corporation and
reselling it for its own account, sells it for the corporation as an agent; it gets
a commission rather than a dealrs profit
Selling group members do not by, they are merely sub-agents
Corporation that is well-established usually use this type in order to save
marketing cost