The Finance Press: 3/15/09

Primary and Secondary Capital Markets

What is the capital market? How is the primary market different from the secondary market?

The capital market refers to the trade of financial securities, such as stocks and bonds, with a long-term maturity date between individuals and institutions. The capital market is comprised of the primary and secondary market. The primary market is where new securities are traded while the secondary market is where used, or previously traded, securities are traded. The capital market relies on the timely interaction between corporations and investors in the primary and secondary market for an efficient system.

In the capital market, the initial step is the selling of financial securities, such as stocks and bonds, to investors by a corporation in order to raise funds through the primary market. A corporation only receives money for its securities the first time they are issued. An initial public offering, or IPO, is the first time a corporation makes its securities available to the public while seasoned new issue refers to additional securities being made available to the public of a corporation that has previously released securities to the public. The corporation then uses the funds that have been raised from the sale of these securities to invest in the organization generating new assets and increasing operations. The cash flow generated from the new assets and increased operations is then reinvested in the organization, paid back to investors (dividends), or paid to the government in the form of taxes.

Once the new securities are traded by the corporation on the primary market, the securities are thereafter traded on the secondary market. The securities are no longer handled by the corporation but are traded among investors. An investor selling a security receives the money for the security and not the original corporation. As stated previously, the corporation would only receive money for the initial sale on the primary market. The securities traded by investors in an efficient market are supposed to represent the expected earnings and risks of the corporation and thus reflect the true value of that corporation.

Sarbanes-Oxley and the SEC

What are three primary roles of the SEC? How does the Sarbanes Oxley Act augment the SEC’s role in managing financial governance?

The three primary roles of the U.S. Securities and Exchange Commission (SEC) are to protect investors, maintain efficient markets, and facilitate capital. The SEC works to protect investors by maintaining oversight of the capital market to insure that as more and more people use the market to invest to increase the livelihood of their families that these investments are protected. The capital market involves securities that have the ability to gain and lose value, which means that investors have the ability to gain and lose money. The SEC monitors and works to maintain the efficiency of the market to protect investors from inaccurate information, unfair trading practices, and unorganized trading.

The Sarbanes-Oxley Act augments the SEC's role in managing financial governance by review of financial statements, enhancing the enforcement program, increased frequency of reviews of investment advisers and companies, and conducts more broker/dealer examinations (SEC, 2003). The Sox Act increases the review of each registrant's financial statements to a minimum of every three years. The Sox Act increases the amount of enforcement allowed so that investigations can occur more quickly and be resolved sooner. The Act increases the frequency of financial reviews of investment advisers and investment companies based on the risk criteria associated with the company. Finally, the Act increases the examinations of brokers and dealers and related branches and offices to maintain monitoring effectiveness.

The Sarbanes-Oxley Act seems to have allowed the SEC to increase effectiveness in the three primary roles of the SEC. The Act increased the ability to protect, regulate, and enforce the three areas allowing the SEC to be increasingly effective in the three primary roles. This increased ability allows the SEC to increase oversight through multiple facets with increased effectiveness and efficiency to further strengthen the capital market.

LLCs and LLPs

What is a limited liability corporation? Limited liability partnership? What are the differences? What are the advantages and disadvantages of each?

LLCs are business structures that insulate owners from personal liability for debts, obligations and other liabilities of the business. LLCs also have pass through taxation, meaning that the business is only taxed once and the members and the business are not both taxed.

LLPs are business structures that insulate owners from the liabilities resulting from other owner's wrongful acts, omissions or negligence. Sometimes, depending on the state, LLPs afford further protections to the owners such as those of an LLC. LLPs also have pass through taxation.

The major difference in most states is that an LLP does not prevent owners of the business from being personally liable for the debts, obligations or liabilities of the business (unless those debts, liabilities or obligation was caused by the acts of another owner). However, an LLC provides protection to the owners from being personally liable for any debts, liabilities or obligations. Another difference is that an LLC is formed by filing articles of organization with the Secretary of State of most states while an LLP is formed by filing a Certificate of Limited Liability Partnership with the Secretary of State.

Advantages of both include the fact that they have pass through taxation, meaning that members of the LLP or LLC are not taxed twice as a business and as individuals. Another advantage of the LLC includes personal liability protection. This along with the pass through taxation, make this a great option for group practices, especially in law and medicine, because it insulates the members' from personal liability in case something occurs which may cause the business to have to pay out a lot of money.
A disadvantage of an LLP is that in most states they do not provide personal liability protection. A disadvantage of an LLC includes the fact that most states have different rules for LLCs so uniformity is lost.

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Can a Company Operate Without Current Liabilities?

What is an Asset? Liability? And how do they differ?

An asset can be defined as any item that adds value to a company. In general, they are divided into current assets (Less then 1 year) and long term (Greater than 1 year). Some examples of assets are inventory, buildings, vehicles, cash, etc. A liability is the opposite of an asset, and can be defined as anything that a company is obligated to contribute assets to resolve. The most common example of a liability is a loan. A loan will allow initially provide a company with cash, but will have to pay it off at a later date with interest. The main difference between assets and liabilities it that assets add value, while liabilities take away value. A company that has more assets than liabilities will have positive equity.

Can a Company Operate Without Current Liabilities?

Although it is unlikely, it is possible for a company to operate without any current liabilities. A company that has ample cash reserves would be able to pay for all assets at the time of purchase. This is not typical because the time value of money prompts companies to invest their cash reserves. Another method of operating with without current liabilities would be financing all assets with long term liabilities. This is also not typical because a company can usually save money on financing costs by utilizing short term loans for seasonal needs.