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SEC Regulation M: Definition & Overview

Instructor: Brad Yeckley

Brad has taught at the university level, has an MBA, and is currently finishing his PhD.

This lesson gives a broad overview and definition of Regulation M and the rules therein. These rules are used to prevent market manipulation of a security offering.

Creation of Regulation M

The Securities and Exchange Commission was created by Congress with the Securities Exchange Act of 1934. This act gave the SEC wide-ranging power to regulate, register, and conduct oversight of the securities industry and those who participate in securities activities. In 1997, Regulation M was enacted to prevent market manipulation by individuals and organizations with a direct interest in the offering of a security. It was introduced as a replacement to Exchange Act 10b-6, 10b-6A, 10b-7, 10b-8 and, 10b-21.

Regulation M strictly bars parties with interest in a security offering from engaging in activities that could artificially inflate or decrease the price of a security. The regulation also prohibits any false representations in the volume or activity of the security being traded in the market. Regulation M contains six rules, numbered 100 to 105, that work in conjunction with each other to prevent market manipulation, thus helping to protect the public.

The general provisions of each rule are highlighted below. Be aware that these rules have more detailed considerations, requirements, and exclusions that are not discussed in this lesson.

Rule 100

This rule is considered a definitional rule and defines the terms and verbiage used within the remaining five rules.

As an example, Rule 100 defines a prospective underwriter as an individual who bids to the issuer of a security offering, or who has a reasonable expectation to be selected by the issuer as the underwriter. This definition holds even if contractual terms have yet to be negotiated and agreed upon.

Rules 101 and 102

Rules 101 and 102 are in reference to securities distributions. The rules restrict the activities of any person or organization participating in or affiliated with a securities distribution. A distribution is considered a securities offering that differs from ordinary trading in both the magnitude or volume of the trades and the use of particular selling efforts. Rule 102 takes Rule 101 a step further in that is has fewer exemptions and covers in more detail distribution participants who may also be issuers and selling security holders of the securities.

Rule 102 is more restrictive than Rule 101. Issuers and selling security holders involved in the distribution have more incentive to manipulate the security because of their interest in the proceeds of an offering.

Rules 103, 104, and 105

Rule 103 allows for passive market making on the NASDAQ. Passive market making is the practice of an underwriter making a bid in the secondary market to purchase shares of a securities issue that the underwriter is partaking in. In this instance, the bid must not be higher than competing offers.

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