Background: Structure of the Markets and Regulation .

Disclosure and Materiality .

o Materiality .

DEFINITION: There must be a substantial likelihood that the disclosure

of omitted fact would significantly alter total mix of info made available

to the reasonable investor (TSC Industries)

STANDARD: In determining the materiality of a contingent event, two

things must be considered: the probability the event will occur, and

the magnitude of the event. (Basic)

“Truth on the Market” defense - If market knows, then the failure to

disclose or the omission or false statement is, in effect, immaterial.

(Wieglos)

Puffing (general representations) about auction process would not lead

reasonable investor to pay more for stock than its worth, as it is a

common practice for someone to be optimistic when selling and only

unreasonable investors would attach importance (Eisenstadt –

auction “going smoothly”)

o Forward Looking Information, Bespeaks Caution and MD&A .

“Bespeaks Caution Doctrine” - Cautionary language ( substantive and

tailored to the situation) in an offering document negates the

materiality of an alleged misrepresentation or omission, making

forward-looking statements non-actionable (Kaufman)

Cautionary language must be meaningfully cautionary - factual inquiry

to determine if factors/potential variances included in language were

the ones the company really thought were the most important (Asher

– statutory safe harbor for forward-looking statements)

o Corporate Governance, Management Integrity and Violations of Law .

Quality of mgmt is a material fact, reflected in interested transactions.

(Franchard)

Inside directors have duty to know substance of interested transactions

negotiated by outside directors, and to know what should be disclosed

to SH's. (Grace)

Criminal prosecution of transactions does not preclude SEC from

instituting an action for failure to disclose the same activity, as long as

remedies are mutually exclusive. (Schlitz)

What is a Security ? Follow these steps: (1) Is it stock?... (2) If not, apply Howey Test

o §2(a)(1) List - stocks, promissory notes, investment contracts, bonds,

debentures, fractional undivided interests in oil/gas/mineral rights, collateral

trust certificates, etc.

Stock is a security

Exception: “Stock” not a security if the “stock” lacks the usual

indicia of stock, i.e. being non-transferable, no right to

dividends, just calling it stock doesn't make it stock) (Forman)

no more “sale of business doctrine”, if called stock and has

stock’s characteristics, purchaser justified in believing fed sec

laws apply; fed sec laws apply not only to passive investors but

also when control is transferred to “entrepreneurs” (Landreth)

Promissory Notes are securities:

Exception : Family Resemblance Test can rebut presumption

that note = security (Reves)

o Seller and buyer intent – was it for investment/financing?

did buyer want profit?

o Plan of distribution of instrument – many ppl buying it?

Trading? Then security.

o Reasonable expectations of investing public – reasonable

reliance, then security

o Existence of another regulatory scheme? – Do investors

need Sec Act protection?

o Investment Contracts (Howey Test)

Investment

In common enterprise

With expectation of profit

Profit must be primary purpose (Forman – no)

This prong passed even if rate of return is fixed (Edwards –

yes)

Solely from the efforts of others

“solely” should be read as “primarily” (Edwards – yes)

Investor inexperience/unfamiliarity with sector proves no

reasonable expectation of investor control – (Leonard – yes,

LLC)

Pre-purchase services of promoters and post-purchase

ministerial functions not enough to meet this prong – (Life

Bookers – no)

o Partnerships, LLC’s and Other Businesses .

Partnerships – Since partnership interests are not on the laundry list

of "securities," you have to put them through the Howey Test.

Big issue with 4th prong: “Solely from the efforts of others”

o General partnerships – almost never pass 4th prong

Exception: general partnership could be security

where 1) the agreement left one partner/venturer

with such little control that it is more like limited

partnership; 2) the partner was so inexperienced

or unknowledgeable in the field; or 3) the partner

was dependent upon unique entrepreneurial or

managerial ability of promoter or manager

(Williamson)

Limited partnerships – frequently pass 4th prong

b/c usually limited partner cannot manage the

corporation and must rely on the efforts of others

to run the business.

LLC’s – same type of analysis as GP/LP, but LLC members likely

participate less than in GP since they have limited liability -> less likely

involved in mgmt -> more likely to pass Howey’s 4th prong.

o Real Estate .

When the seller of real estate offers a collateral arrangement offering

some post-acquisition , a condo may be an investment contract.

Key inquiry --> whether the condo is coupled with a service contract

and profits are expected from the purchase of the condo.

Hocking (distinguished from other real estate sale cases) -

facts creating genuine issue as to whether condo and RPA were

part of same package/transaction was enough to defeat SJ

motion – emphasis placed on economic benefit of managerial

efforts of third party

o Notes, Derivatives, etc. Ch. 2.F-H (Text pp. 65-91).

Notes: See Promissory Notes and Family Resemblance Test from

Reves, at top of page 2

Derivatives: FINISH THIS!!!!!!!!!

The Public Offering .

o Issuer (company) arranges with financial firms (underwriters) to distribute

securities to investors

Two types:

Firm commitment offering – Underwriters act as dealers i.e.

they commit to purchase securities (actually buy them) from

the issuer and resell them to the public at a fixed price. Their

commission is the difference b/t purchase price and resale

price.

Best efforts offering – Underwriters act as brokers i.e. they

help the issuer sell the securities. Their commission is a

percentage of the offering proceeds from shares actually sold.

Best efforts offering may be in the form of “straight” (least risky

to underwriter), “mini/maxi” or “all or none” (most risky to

underwriter) depending on the threshold number of shares that

must be sold before the offering can close and the underwriter

can earn its commission.

o Process/Documents:

Letter of Intent: Worded not to be binding, indicates managing

underwriter’s willingness to organize the offering

Issuer has to get company ready for offering: preparing financial

information SEC will need, making sure house is in order, etc.

Registration Statement: Includes the prospectus, describes the

offering and issuer, must be filed with the SEC, and the prospectus

becomes principal selling document for offering; prepared by counsel

for issuer and reviewed by counsel for managing underwriter

Comfort Letters: Issuer’s counsel sends to underwriters letting them

know house is in order and also confirming accuracy of

financials/accounting.

Agreement Among Underwriters: Once syndicate is assembled,

underwriters enter into agreement right before registration statement

becomes effective, authorizing managing underwriter to negotiate with

issuer on their behalf.

Underwriting Agreement: Issuer enters into this with each

underwriter, and it is signed on their behalf by managing underwriter

(who drafts it) after the market closes on the night before the offering:

specifies price and amount of securities offered and each underwriter’s

allotment

Selling-Group Agreements: Underwriters enter into agreements

with securities firms that act as retail dealers (“selling group”),

finalized just before offering begins (this isn’t done if the underwriter’s

firm has an in-house retail department)

o Four classes of issuers - Rule 405

Well-known Seasoned Issuers (“WKSIs”) – enormous amount of

securities outstanding; through the “automatic shelf registration

process,” issuer can file a three-year registration statement and re-file

every three year; registration becomes automatically effective when

filed and without SEC staff review.

Seasoned Issuers – eligible to use Form S-3 to register securities; can

incorporate company-specific information by reference from ’34 Act

filings.

Unseasoned Issuers – use Form S-1; applies to IPO and companies

that have been public for only a short period of time (~ 2 years)

Non-reporting issuers – issuers that are not required to file ’34

reports.

o Registration of Public Offerings

Registration for Non-reporting issuers

Pre-filing period – begins when issuer prepares for offering –

“in registration”

o Prohibited: Offers (5(c)), Sales (5(a)(1)), Deliveries (5(a)

(2))

o Permitted:

Prelim negotiations with/among underwriters

§2(a)(3)

Issuer announcements of proposed offering - Rule

135

Issuer communications 30+ days before offering -

Rule 163A

Regularly released information - Rule 169

Waiting period – after registration statement is filed, before

effective

o Prohibited: prospectus unless it complies with §10

o Permitted:

Oral offers (unless SEC issues refusal

order/investigation)

Prelim negotiations with/among underwriters-

§2(a)(3)

Tombstone ads, IDing statements interest

requests-§2(a)(10(b)

Preliminary (red-herring) prospectus - §10(b),

Rule 430

Summary prospectus - §10(b), 431

“Free-writing pro” with/after prelim pro §10(b)-

Rules 164, 433

o Required: Distribution of preliminary prospectus-Rule

15c2-8

Posteffective period – after becomes effective, until offering

ends

o Prohibited: prospectus unless it complies with §10

o Permitted:

Oral offers (unless SEC issues stop order)

Distribution and Sale of securities

Tombstone ads, IDing statements interest

requests-§2(a)(10(b)

Free-writing communications - §2(a)(10)(b)

Final prospectus - §10(a)

o Required:

Written confirms for allotment sales & dealer

sales - (5)(b)(1)), Rules 172, 174, Rule 10b-10

Delivery of notice within two days after sale -

Rule 173

Registration for WKSIs (WKSI =

Pre-filing period

o Permitted

Oral offers – Rule 163

“Free-writing pro” with/after prelim pro §10(b)-

Rules 164, 433

Regularly released forward-looking info – Rule

168

Waiting period

o Permitted

Free-writing prospectus w/out prelim prospectus –

Rule 433

Posteffective period

o Permitted

Free-writing communications w/out prelim

prospec – Rule 433

o Required

Notice delivery only applies to allotment sales -

§4(3), Rule 174

Contents of Registration Statement

Form S-1 - for non-reporting issuers (making IPO) or small or

unseasoned reporting issuers; the reporting ones who are

current in Exchange Act filings for the past year can incorporate

company-related info by reference to SEC filings

Form S-3 – for large, seasoned companies that have been

reporting for at least one year; streamlined prospectus

describing particular offering, prospectus can incorporate by

reference info from company’s reports filed under Exchange Act

Exempt Transactions .

o always check for integration, which may make transaction not qualify for

exemption

o Private Placements .

Section 4(2) exempts “transactions by an issuer not involving any

public offering” – turns on whether the particular class of persons

affected need protection of the Act.

For 4(2) exemption to apply, investors must:

Be sophisticated (i.e. can “fend for themselves”);

Have access to info substantially the same as that found in

the reg statement

NOTE: Burden of proof is on the Issuer. (Ralston)

Factors to consider for exemption (Doran): (NOTE: not dispositive)

1. Number of offerees – but focus on access & sophistication,

relation to issuer, since this is not quantitative – WORRIED

ABOUT PROTECTING THE INVESTORS

2. Number of Units Offered;

3. Size of the Offering; and

4. Manner of the Offering.

Resale restrictions: You want to make sure investor isn’t trying to resell

or exemption fails.

“Investment letter” – signed statement from investor that s/he

is purchasing this security for “investment purposes and

without a view to distribution”

Inscribe a legend on the certificate of stock – disclosing that this

security is unregistered may be transferred only if specified

conditions are met.

Stop-transfer order – instructs the transfer agent not to process any

transfer of restricted securities without the consent of the issuer.

If purchaser violates resale retriction, issuer okay as long as did

one of these things

o Regulation D Limited Offerings, Integration .

Reg. D is a safe harbor covering both private placements and limited

offerings.

Must register Form D within 15 days of first sale if using one of

these exemptions

Failure to comply fully doesn’t matter if insignificant.. if it didn’t

harm investor

Integration may destroy any of these exemptions: To determine

integration, ask if one of these fits: 1) Single plan of financing;

2) Same class; 3) Timing; 4) Type of consideration; 5) Same

General Purpose

Three Rules for Reg. D:

o Rule 504:

an exemption for small offering of up to $1M

(usually start-ups);

not available for reporting or investment

companies;

no limit on # of purchasers

resale restriction (unless state blue sky allow, or

certain circumstances)

no affirmative disclosure requirements, but

States may require disclosure filings –blue sky

laws regulate this pretty much

Prohibits general advertisements unless blue sky

allows

Not general if pre-existing relationship

with offeree

o Rule 505:

an exemption covering offerings of up to $5M;

limit of 35 non-accredited purchasers; accredited

investors not counted

affirmative disclosure obligations to non-

accredited investors

resale restriction

Prohibits general advertisements: must have pre-

existing relationship

o Rule 506:

safe harbor for a § 4(2) non-public offering

exemption;

no limit on offering amount;

limit of 35 non-accredited purchaser;

non-accredited investors must meet affirmative

disclosure obligations + sophistication

requirement (knowledge/experience) 506(b)(2)(ii)

resale restriction

Prohibits general advertisements: must have pre-

existing relationship

o **Rule 501(a)** – Definition of “Accredited

Investor” – (can fend for selves.)

Institutional investors, big organizations ($5mil

assets), key insiders (of the issuer), millionaires,

fat cats, venture-capital firms, sophisticated trust,

accredited-owned entity.

NOTE: if issuer reasonably believes investor is

accredited, it counts

o Regulation A of the Securities Act of 1933 (aka Reg A) exempts small

offerings of securities from the regular SEC registration if these conditions

are met:

The public offering is not for more than $5,000,000 within a 12-

month period.

The offering statement, which is a simplified disclosure

document, must be filed with a Regional Office of the SEC at

least 10 days before the issue is offered for sale.

The offering circular, which is similar to the prospectus in

providing full disclosure, must be sent to each buyer of the

issue at least 48 hours before the confirmation of the sale.

The offering circular must be revised if the issue is still being

offered 9 months after the initial issue, and the issuer must file

a sales report of the issue with the Securities and Exchange

Commission (SEC) every 6 months until the offer is terminated.

Secondary Distributions: How Can I Sell My Stock ?

o §4(1) - an exemption that allows transactions by persons other than issuer,

underwriter or dealer – they are exempt from the registration requirement of §

5 ’33 act

Everyone involved is PRESUMED TO BE UNDERWRITER unless proves

otherwise

if determined to be underwriter, this section can’t apply, and you have

to try 4(2), § 4(1)

Possible “underwriters” who don’t get exemption:

persons who buy unregistered securities in a private

placement or other exempt offerings and now want to resell

them (without waiting)

persons who sell securities on behalf of “control persons”

(persons who control, are controlled by, or are under

common control with, the issuer (e.g. management,

directors, major shareholders) (Wolfson)

§2(11) does not say that a "control person" is an issuer and

therefore subject to the registration and prospectus delivery

requirements. Rather, it only says that solely for the

purpose of determining whether another person is an

underwriter, the term "issuer" also includes "control

persons". That is, one can be an underwriter if one buys

securities directly from issuer itself or if one buys them from

an officer or director of the issuer (because of the danger

that she is acting indirectly for the benefit of the issuer).

“Underwriter” is broadly defined to include:

o any person who purchases from an issuer with a view

to distribution (i.e. a typical firm commitment

underwriter)

o any person who sells for an issuer in connection with

distribution (i.e. best efforts underwriter)

o Any person who participates , directly or indirectly , in

any such undertaking

o CHINESE CONSOLIDATED: issuer need not authorize

or compensate selling activities of solicitor for that

solicitor to be considered an “underwriter”, since

purchaser still deserves the information and protection

of registration.

o §4(1½) – Exemption construed to provide for the private resale of securities

to sophisticated investors

resale of securities to private, sophisticated investor (Ackerberg –

not “UW” if securities held for a while before resale – like the

holding period in Rule 144) – Control person/affiliate can use

You still wanna ask if its an UW, etc, just like with 4(1) so this is

pretty much 4(1) analysis but it is just specific to resales for private

investors, not issuer

Just like a 4(2) exemption (but for non-issuer/uw/dealers and for

resale) – limited number of purchasers, disclosure of info that would

be given in private placement, sophistication req, - also you have to

wait 6 or 12 months before reselling – don’t have to follow all the

4(2) req’s though.

If purchaser (non-issuer) bought securities without original intent to

distribute them, but at a later time decides to resell them, he/she/it

may do so without destroying the relevant exemption only if the

resale buyer is "sophisticated" and provided with the same

information as would be available if the securities were registered.

o Rule 144 . If restricted securities are being redistributing publicly (mutually

exclusive of 4(1½ ) – Control person can use this. (if volume too high, or

problem like that, try 4(1.5).

Persons selling restricted shares pursuant to Rule 144 will not be

deemed an underwriter – safe harbor for ordinary public trading (can

be control or noncontrol person, as long as follow rules -285 – different

for affiliates/non-affiliates)

Restricted securities—as defined in Rule 144(a) (3)—are

securities that can be resold under Rule 144 - Important for the

investor to meet this definition

“Restricted securities” include: securities acquired from

issuer in a transaction not involving any public offering;

securities acquired from issuer that are subject to the resale

limitations, such as securities acquired in §4(2) private

placement, Reg. D offering, or 144A transactions.

Securities acquired in an intrastate offering are NOT

restricted securities.

If the subscription statement contains the resale limitations

provision, the investor can invoke Rule 144 in resale, even

though the issuer actually failed to qualify for Rule 505, for

example.

Mandatory holding period à this requirement is to track

the case law on investment intent.

A non-affiliate of a public company cannot resell during the

first 6 months, can resell subject to conditions during the

next 6 months (i.e. current information condition), and after

1 year, can do free trading.

o Rule 144A . Institutional Trading: codifies 4(1½) for institutional

investors (ALL are QIB, no holding period)

Rule 144A permits the sale of unregistered securities to qualified

institutional buyers (QIB), which are institutions—banks, insurance

companies, etc.—that invest at least $100 million in securities from

issuers not affiliated with the QIB. This is how most unregistered

foreign securities are sold in the United States. – collateralized debt

obligations

Figure out if it is a QIB or not -

Like 4(1-½)

4(1.5) allows individuals to resell unregistered securities to other

individuals;

144A enables institutions to resell unregistered securities to other

qualified institutions

Reorganizations and Acquisitions. – need to finish.

o The Sales “For Value” Requirement of Section 5:

o Generally - Section 2(a)(3) says that only a sale “for value” must be

registered under section 5. When an issuer sells shares in a public

offering, it is very clear they are selling the securities for value, and that

these sales must be registered under section 5. On the other hand, cash

or stock dividends are clearly not “for value”, as the corporation gets

nothing in return; therefore, these transactions need not be registered.

o Unclear Transactions – Are they “For Value” and Subject to

Registration?

Cash or Stock Choice Dividend - When corporations give

investors a choice – you can have a cash dividend or a stock

dividend. In this case, the SEC says that since neither of these

dividends on their own is considered “for value”, we do not make

the corporation register this as a sale.

Cash Dividend, Converted to Stock - However, if a corporation

declares a cash dividend, and only afterward decides to give people

the opportunity to get a stock dividend instead of the cash, this

must be registered as a sale. Why? The moment they announce a

cash dividend, the cash belongs to the stockholders. If they then

trade this for a stock instead, they are really buying the stock – it is

for value.

Materially Amending the terms of a security (stocks or

bonds) – is this considered a sale that must be registered? To

change the terms, you must take a vote among shareholders to see

if they will accept the proposed change. When you make this

change of terms, is this really an exchange of the old stock for a

new type of stock, which qualifies as a sale? The prevailing view is

that if the terms are changed in any significant way, this is

considered a sale that must be registered. However, there is an

exception under 3(a)(9) that can exempt a change of terms from

registration.

Converting a Security – when you convert preferred stock into

common stock without making any additional cash payments

o Spin offs – only permitted with legit biz purpose, also focus on SH’s getting

info or not

issuance, by a company with little or no business activity, of some

of its shares to a publicly owned company for a nominal

consideration.

publicly-owned company then spins off its shares as a distribution

to its shareholders. Creating a public trading market into which the

insiders can sell the remaining shares.

the total transaction requires registration under 33 Act, even

though the distribution to the shareholders of the public-owned

company is not a sale. SEC v Datronics [4th 1973]

reason for Datronics holding: Spin-off with no legitimate

business purpose is a “sale” under the ’33 act because it creates a

market for the new securities; therefore, new securities must be

registered

o Shells

shell corporation is one which has ceased active operations and has

little or no assets, but has substantial amounts of stock held by

members of the public.

promoters obtain control of the company, engage in a series of

acquisitions or other transactions which cause the market price of the

stock to rise dramatically, then take advantage of the inflated market

to sell the shares that they have acquired.

SEC said that transactions of this type violate both the registration

and antifraud provisions.

Exchanges and Reorganizations In and Out of Bankruptcy. Ch. 7.C-D

(TEXT pp. 417-428).

“For

1933 Act Liability.

o §11 Liability – misinfo in reg statement

P – “acquirer” of securities (hard to show if didn’t get them directly

from UW or Dealer)

P, if an acquirer, just has to show material misrepresentation in reg.

statement.

Culpability, reliance, causation are defenses.

Potential Defendants = UW’s, Issuers (and its officers), some experts

who were involved

Damages = 3 possibilities 11(e) – difference between the

amount paid for security (not greater than public offering price

and:

o The value of securitiythe date suit filed if security still

held

o The price of securitiy if sold before suit is filed

o The lesser of the above two options if sold before

judgment but after suit filed

o §12 Liability

12(a)(1)

Unregistered, non-exempt securities or violation of gun-jumping

– violating §5

Damages = rescission or rescissionary damages if sold

12(a)(2) – for misinfo in prospectus or oral communication

kind of extension of §11 for purchasers of securities (not just

acquirers like in §11)

Purchasers may seek rescission from “statutory sellers” if the

offer was carried out using prospectus or oral communication in

offering with material false or misleading statements.

Reasonable care defense can be raised if they show they didn’t

know of misinformation.

o §17(a) Liability

liability on sellers of securities – whether public/private offering or even

for exempt ones

liability for negligent misrepresentations, broad sweeping to prevent

any fraud

Prohibits sale of securities using jurisdictional means that

Employs ‘artifice to defraud’

Obtains money by means of material misstatement or

misleading omission, and

Engages in actions that ‘operate as a fraud’

1934 Act Liability: Securities Fraud.

Scope of Rule 10b-5: ‘In connection with the purchase or sale of a security’

o Covers all types of securities and all types of transactions (a last resort

provision for Ps)

D does NOT have to be party to a transaction; D’s actions must

merely be reasonably calculated to influence the investing public.’

(Texas Gulf Sulfur)

P has to be involved in a purchase or sale. Blue Chip Stamps v.

Manor Drug Stores (U.S. 1975)….. thus the SC limited the TGS

standard from excessive exploitation in private suits. SC’s tone

was aggressively set against the rise of the securities class action

industry that arose following TGS).

In connection with…’”

(a) No showing of causality required

(b) Simply requires some nexus between the sale of

the security and the alleged fraud (eg, typically

courts accept that such nexus when time overlap, eg,

defective disclosure in Jan is not discovered until

June; anyone who purchases secs from Jan to June

can be a P in the lawsuit)

(c) Security sale must be the main part of the fraud

(not a larger investment scheme with a security

incidentally involved)

What is a purchase or a sale? It includes –

Sales as defined in the 33 Act

transactions that impose encumbrances, such as

pledges. Chemical Bank

Issuance of securities

Options

Agreements to purchase stocks in the future:

Promissory Fraud. Wharf

Scienter (recklessness counts, negligence doesn't)

P must be aware that her actions are actually going to harm

investors. (Hochfelder)

Recklessness – yes… (awareness of true state of affairs

and “could reasonably foresee result” is enough – AUSA Life

Insurance v. Ernst, Sanders, Broad

Scienter may be satisfied if—

(1) D actually intended the fraud, or

(2) D was aware that her actions could possibly result

in defrauding investors, and she was okay with it.

AUSA.

o Does ignorance of the law constitute scienter? - Ds

cannot claim ignorance of fraud if the statement is

material enough – usu in auditing and in accounting

statements.

The Duty to Disclose under 10b5 .

If a corporation speaks, must speak accurately (Basic v. Levinson)

For now, corporations only have a duty to reveal material information to investors

periodically – annually and quarterly. The real question becomes “gap

disclosure” – what duty does a corporation have to disclose material information

in between the periodic disclosure statements.

When there is no duty to speak under securities law, the courts look to fiduciary

duty law and corporate law to fill the gaps and determine what and to whom

corporations must disclose

Internal valuations – generally no (Facebook), but there are some unusual

circumstances

Just because a particular officer knows fraud is going on, it does not mean the

entire company can be sued. If statements are made to newspapers, but it is

unclear who made them, can the company be sued? If a lower level person made

the statements, the company is probably not liable.

As long as statement was true when made, no duty to update, But if company

realizes earlier statement was false, there is a duty to correct (Gallagher).

o 3 rd Circuit is tougher , and assumes duty to update exists as long as

statement “alive” (Weiner)

o also see Time Warner – P claim not dismissed, company made material

change in plans and there was no update to shareholders – could reconcile

with Gallagher since the company probably knew it was considering this

other option all along and didn’t mention it, or 2nd circuit just tougher than

7th)

o There is exception for duty to disclose material info if it would prejudice a

company objective

New York Stock Exchange’s Additional Disclosure Requirements

o The NY stock exchange has standards for remaining listed that require

disclosure on a more continuous basis than the securities laws do,

effectively resulting in far greater disclosure among its listed companies.

Reg. FD – If you disclose information to anybody outside of the corporate family,

you must reveal that information to the entire market through an official SEC

disclosure. (like protection against tipping, Ins Trad)

14(e)3 – Tender Offers

← Reliance; Causation and Fraud on the Market in 10b5

Reliance

o Presumption of Reliance in Face to Face Dealings (Ute) – In a case

of face to face negotiations with a fiduciary we have a presumption of

reliance upon the defendant’s omissions. This presumption is based on

“the circumstances of this case” – the presumption is limited to the facts

of this case.

o Presumption of reliance in Class action (Levinson) – Fraud on the

Market - the plaintiff has the burden of proof on all of the elements of

fraud – including reliance. If the plaintiff had to prove individual reliance,

the lawyers would have to prove that each particular member of the class

relied on the omission / misstatement. This is completely impractical;

therefore, the only way to make this work is to get a presumption of

reliance. (SC adopts this)

Defenses (Levinson) – rebutting presumption of reliance:

Truth on the market, Severing the link between omission

and purchase, or prove EMH shouldn't apply because

company not public enough for it to work, Plaintiff’s reliance

was reckless – not reasonable at all.

Loss Causation

o Definition – the transaction caused the loss to the plaintiff. Loss

Causation is basically proximate causation (with some tweaks)

o Usual Situation - The plaintiff shows that he bought the price at one

price, and then the value went down because of the misstatement or

omission. The defendant tries to sever this link. (AUSA – no causation)

AUSA – Majority focuses on foreseeability, concurrence is more pro-

defendant – asking did the misinformation cause the loss, and

dissent is pro-plaintiff – there was misinformation that was relied on

here, and otherwise plaintiffs could’ve gotten out.

Dura Pharmaceuticals v. Broudo - 9th Circuit is Lenient on P’s

Pleading Standards – The 9th circuit held that it is enough for the

plaintiff to plead that the price of the stock was inflated on the day

I purchased it because of the misrepresentation (the company

reports inflated earnings).

Supreme Court is Stricter - The Supreme Court says that this is

not proof of loss. You have to show not just that you bought the

stock and lost money, but that you lost money because of the

misrepresentation. The plaintiff must plead that the diminution of

price is attributable to the defendant’s misstatements. Here the

plaintiff did not even plead this!

o The purpose of the securities laws is not to protect investors from the loss

of their investments due to bad business decisions – it’s only to prevent

against fraud. The plaintiffs argue that the defendant’s fraud was the

proximate cause of the securities’ loss in value

o

← Manipulation . Ch. 12.H. (Text pp. 733-43)

Enforcement.

o Private Rights of Action : Ch. 13.A (Text pp. 745-55).

o Secondary Liability : Ch. 13.B-C (Text pp. 755-83).

o SEC Enforcement : Ch. 13.G. (Text pp. 803-30).

o Professional Responsibility : Ch. 13.H-I (Text pp. 830-862).

Rule 205

SOX says SEC has authority to discipline authority; definition of

“practicing” for attorney is so broad, includes giving advice with

respect to filing or non-filing of docs and helping clients draft docs,

almost anything a sec lawyer does

Law firm’s liability in aiding and abetting the fraud was based solely

upon silence during the course of the closing proceedings despite

knowledge of the client’s misrepresentations, rather than some kind of

affirmative misrepresentation on behalf of the client in an opinion

letter. (Nat’l Student Mrkting)

o Criminal Enforcement : Ch. 13.J (Text pp. 862-78)

o Classic Theory; Tippers and Tippees . Ch. 14.A-B (Text pp. 879-87), Ch. 14.E 1.

(Text 898-906).

Rule 10b5 prohibits any person to profit based on material inside

information, or to be an accomplice to someone else who will profit.

“Abstain or disclose” ALWAYS THE RULE – but can’t disclose and run,

must wait a bit (TX Gulf)

Only have to disclose if there is a fiduciary duty, otherwise

silence not enough (Chiarella)

Classic theory of insider trading = trade in securities of issuer on info

that belongs to issuer

illegal insider trading occurs only when there is a breach of

fiduciary duty (Dirks)

o Duty not automatic with spouse or family; decided on

case by case basis, look at whether expressly accepted

duty to not use info, or duty based on past dealings

(Chestman)

o Insider must use/disseminate material non-public

information for personal benefit. (level of benefit unclear

– “vengeance”, giving gift may be enough. (Dirks)

o (classic) Insider:

duty to corp/SH Access to info as EE is not

enough (Chiarella)

But now corps make you sign

confidentiality K’s

Need chain of obligation of confidentiality all way

issuer (Chestman)

Corporate lawyer W has duty to H who relies on

her advice, trusts, confides in her (Weiss)

Test of Materiality is a balance between: (TX Gulf)

o (1) Chance of event occurring (Goodwin – speculative

theory)

(2) materiality of event. (merger? Etc.)… Court

generally looks to

(3) Importance attached to information by those

who knew about it.

Amount bought or sold can be indicative

of whether the insider thought it was

material.

Standard for Materiality:

o Whether a reasonable investor would attach importance

to the information in determining his choice of action in

the transaction. (TX Gulf)

Equal Access Rule (replaced by Dirks’ fiduciary duty

rule) All insider trading is illegal, everybody should have equal

access to information (TX Gulf Oil) – replaced by Dirks fiduciary

duty rule

Tippee – liable if tipper (insider who tips) breached a fiduciary

duty to disclose the info, and tippee knows/should know there

was a breach but trades anyway.

o To have a duty, must be expectation that “tipper” would

have kept info confidential - check to see if spouse,

child, parent, sibling, etc. [10b(5) – 2(b)(3)]

o Tipper only breaches fiduciary duty if tipper gets a

personal benefit (doesn’t have to be monetary, feeling of

giving gift, vengeance, etc) (Dirks)

o Misappropriation Theory, Reg F-D, Rule 14e-3 . Ch. 14.C-D (Text pp. 887-98),

Ch. 14.F-G (Text 912-18).

Misappropriation – (O’Hagan) – CORPORATE OUTSIDER – CAN STILL

ABSTAIN/DISCLOSE

Breach of Fiduciary duty when person is confidentially entrusted

with information by employer and profits from information

(O’Hagan – partner at law firm may not profit from inside

information received predominantly through the partnership.)

No breach however if employee discloses and employer permits

the insider trading.

o Defenses: info not material, only speculative, no benefit to tipper/insider, gave

information inadvertently, also if you had preexisting trading plan (10b(5)-1(c)

o [14e-3(a)] for tender offers] – even when above theories don’t apply, can still

be liable for tender offers