In an Atmosphere of Increasing Scrutiny of Securities Trading GMAT Reading Comprehension

Reading Passage Question

In an atmosphere of increasing scrutiny of securities trading, a fundamental issue is often overlooked. Before the Securities and Exchange Commission can take any action to prosecute wrongdoing under the Securities Acts of 1933 or 1934, a definitional threshold must be addressed. The Acts each offer a slightly different definition of security, but these definitions were left intentionally broad by Congress to keep the Acts from becoming outdated as investment instruments evolved. Intuitively, stock would clearly seem to be a security. It is probably the clearest example of a security and is listed in both Acts' definitions. The Supreme Court, however, has refused to allow the apparent form of an investment to be conclusive proof of its substance. Instead, the Court has adopted its own method for examining the "economic reality" of a particular stock and defines it as a security only if it really has the traditional characteristics of stock. The most common feature of stock is the right to receive dividends contingent upon an apportionment of profits. The other traditional characteristics are: negotiability; ability to be pledged or hypothecated; voting rights conferred in proportion to the number of shares owned; and ability to appreciate in value.

The Court has recognized that of all instruments, stock represents to many people, both trained and untrained in business matters, the paradigm of security. Because of the high expectation that trading in stock is covered by the Acts and the fact that stock lends itself to consistent definition, the Court awarded stock a unique status. If an instrument is called stock and has the above listed characteristics, then it will be considered a security without any further investigation into the surrounding circumstances. The Court emphasises that this special treatment may not be appropriate even for other instruments enumerated in the Acts' definitions and expressly left for another day the question whether notes or bonds or some other category of instrument might be shown by “proving only the document itself.” As a result, more sophisticated modern instruments may unexpectedly fall beyond the purview of the SEC and the Acts completely.

In an atmosphere of increasing scrutiny of securities trading’ is a GMAT reading comprehension passage with answers. Candidates need a strong knowledge of English GMAT reading comprehension.

This GMAT Reading Comprehension consists of 4 comprehension questions.

The GMAT Reading Comprehension questions are designed for the purpose of testing candidates’ abilities in understanding, analyzing, and applying information or concepts. Candidates can actively prepare with the help of GMAT Reading Comprehension Practice Questions.

Solution and Explanation

1. According to the passage, all of the following are true EXCEPT which of the following?

1. The Supreme Court can overrule jurisdictional determinations made by the SEC with respect to definitional interpretation of the Securities Acts.
2. Investigation of the economic reality of a security involves consideration not only of the label and form of the security in question, but also requires examination of the particular characteristics of the actual instrument.
3. The failure of Congress to adequately define a basic term in the Securities Act has led to a widespread uncertainty that has dangerous repercussions for securities fraud investigations.
4. The increased scrutiny of modern securities trading may lead to a disregard of potentially important definitional concepts.
5. An instrument listed as an example of a security in the section of the Acts defining a security may nevertheless be deemed not to be a security.

2. The passage most closely supports which of the following statements?

1. The Securities Acts are flexible documents with sufficient leeway to adapt to modern situations without the need for revision.
2. An instrument characterized by negotiability, the ability to be pledged or hypothecated, voting rights conferred in proportion to the number of shares owned, and ability to appreciate in value will be deemed a security.
3. The Supreme Court has been fair and thoughtful in its interpretation of the Acts' definitions of security.
4. The most important feature of stock is the right to receive dividends contingent upon an apportionment of profits.
5. Modern instruments are more sophisticated than those in contemplation during the drafting of the Acts.

3. What is the main point of the passage?

1. Stock is the most paradigmatically security-like of all instruments.
2. Tighter scrutiny on the SEC is necessary in the current era of increasing scrutiny on securities trading lest the Commission overstep its jurisdiction and prosecute cases which fall outside the statutory definitions of a security.
3. The Supreme Court has appropriately ruled to give stock a special status among instruments.
4. The definition of a security can be an important issue even for instruments which seem clearly to fall within the Acts' definitional parameters.
5. The Supreme Court has had an important role in developing and defining SEC enforcement activities.

4. Which of the following can be correctly inferred from the passage with respect to the relationships between various parties to securities trading or the regulation thereof?

1. Because of definitional uncertainties, unsophisticated traders or investors should seek professional advice before making assumptions about the SEC's jurisdiction over any particular trade or instrument.
2. Multiple branches of the federal government can affect a trader's or investor's rights.
3. The Supreme Court has not ruled on whether notes or bonds can be defined as securities by proving only the document itself.
4. Because of the Supreme Court's ruling regarding the economic reality of securities under consideration, stock can generally be considered to be a security.
5. Judicial over-interpretation has complicated what would otherwise be a straightforward determination by the SEC of its substantive jurisdiction.

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