BUSINESS LAW TodaySTANDARD EDITION TEXT & SUMMARIZED CASES, 12e

Roger LeRoy Miller

Miller, Business Law Today, Comprehensive Edition: Text & Cases, 12th Edition. © 2020 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Investor Protection, Insider Trading, and Corporate Governance

Chapter 30

Chapter Outline

36-1 Securities Act of 1933

36-2 Securities Exchange Act of 1934

36-3 State Securities Laws

36-4 Corporate Governance

Learning Objectives

What is meant by the term securities?

What is insider trading? Why is it prohibited?

What are some of the features of state securities laws?

What certification requirements does the Sarbanes-Oxley Act impose on corporate executives?

36-1 Securities Act of 1933 (slide 1 of 2)

36-1a What Is a Security?

Preferred and common stocks, treasury stocks, bonds, debentures, and stock warrants

Stock options, puts, calls, or other types of privilege on a security or on the right to purchase a security or a group of securities on a national security exchange

Notes, instruments, or other evidence of indebtedness

Fractional undivided interest in oil, gas, or other mineral rights

Investment contracts

36-1 Securities Act of 1933 (slide 2 of 2)

36-1a What Is a Security?

The Howey Test

An investment contract is any transaction in which a person (1) invests (2) in a common enterprise (3) reasonably expecting profits (4) derived primarily or substantially from others’ managerial or entrepreneurial efforts.4

Case Example 36.1 State v. Nistler (2015)

Many Types of Securities

Stocks and bonds issued by corporations are the most common securities.

36-1b Registration Statement (slide 1 of 2)

Prospectus

A written document required by securities laws when a security is being sold.

Contents of the Registration Statement

Securities being offered for sale, including their relationship to issuer’s other securities

Corporation’s properties and business

Management of the corporation

How the corporation intends to use proceeds of sale

Any pending lawsuits or special risk factors

36-1b Registration Statement (slide 2 of 2)

The Registration Process

Prefiling Period: Issuer normally cannot sell or offer to sell the securities.

Waiting Period: The securities can be offered for sale but cannot legally be sold.

Posteffective Period: The issuer can offer and sell the securities without restrictions.

Well-known Seasoned Issuers (WKSI)

Firms that have issued at least $1 billion in securities in the last 3 years or have outstanding stock valued at $700 million or more in the hands of the public.

36-1c Exempt Securities

Exempt securities

Are low-risk investments or are regulated by other statutes

Maintain their exempt status forever

Can be resold without being registered

Include the following:

Government-issued securities.

Bank and financial institution securities

Short-term notes and drafts

Securities of nonprofit, educational, and charitable organizations.

36-1d Exempt Transactions (slide 1 of 3)

Regulation A Offerings

Securities issued by an issuer that has offered less than $50 million in securities during any twelve-month period.

Two types of public offerings: Tier 1 and Tier 2

Important Rule Changes

Cap for Regulation A offerings is $50 million.

Testing the Waters:

Companies can “test the waters” and find out potential interest from investors without selling securities or requiring investor commitment.

36-1d Exempt Transactions (slide 2 of 3)

Small Offerings—Regulation D

Rule 504: Noninvestment company offerings up to $5 million in any twelve-month period

Rule 506—Private Placement Exemption: Private, noninvestment company offerings in unlimited amounts if these are not generally solicited or advertised

Resale and Safe Harbor Rules

Resales of restricted securities trigger registration requirements unless the sales fall under Rule 144 or Rule 144A (“safe harbors”).

36-1d Exempt Transactions (slide 3 of 3)

36-1e Violations of the 1933 Act

Remedies

Violators may be fined and/or imprisoned.

Defenses

The statement or omission was not material.

The plaintiff knew about the misrepresentation at the time of purchasing the stock.

The defendant exercised due diligence in preparing the registration and reasonably believed at the time that the statements were true and there were no omissions of material facts.

Case Example 36.5 Litwin v. Blackstone Group, LP (2011)

Case 36.1

Omnicare, Inc. v. Laborers District Council Construction Industry Pension Fund (2015)

Would a reasonable investor have cause to complain if an issuer, without having consulted a lawyer, states, “We believe our conduct is lawful”? Explain.

36-2 Securities Exchange Act of 1934

36-2a Section 10(b), SEC Rule 10b-5, and Insider Trading

Basic elements of a securities fraud action:

Material misrepresentation

Scienter

Reliance by plaintiff on material misrepresentation

Economic loss

Causation

36-2a Section 10(b), SEC Rule 10b-5, and Insider Trading (slide 1 of 3)

Insider Trading

Occurs when persons buy or sell securities on the basis of information that is not available to the public.

Disclosure under SEC Rule 10b-5

Fraudulent trading

Dividend change

Contract for sale of corporate assets

New discovery, process, or product

Significant change in firm’s financial condition

Potential litigation against company

Classic Case 36.2

Securities and Exchange Commission v. Texas Gulf Sulphur Co. (1968)

Affirmed the principle that the test of whether information is “material” for SEC Rule 10b-5 purposes, is whether it would affect the judgment of reasonable investors

36-2a Section 10(b), SEC Rule 10b-5, and Insider Trading (slide 2 of 3)

Outsiders and SEC Rule 10b-5

Tipper/Tippee Theory: “Tippees” who receive inside information as a result of a fiduciary breach are liable.

Case Example 36.7 “SEC Charges Group of Amateur Golfers in Insider Trading Ring”

Misappropriation Theory: A person who wrongfully obtains inside information and trades on it for personal gain is liable.

36-2a Section 10(b), SEC Rule 10b-5, and Insider Trading (slide 3 of 3)

Insider Reporting and Trading—Section 16(b)

The corporation can recapture all profits realized by an insider on a purchase and sale, or sale and purchase, of its stock within any six-month period.

The Private Securities Litigation Reform Act

The act provides a “safe harbor” for publicly held companies that make forward-looking statements.

36-2b Regulation of Proxy Statements

Section 14(a) of Securities Exchange Act of 1934 regulates solicitation of proxies from Shareholders of Section 12 companies.

36-2c Violations of the 1934 Act (slide 1 of 2)

Scienter Requirement

Case Example 36.10 Altayyar v. Etsy, Inc. (2017).

Scienter Not Required for Section 16(b) Violations

Liability under Section 16(b) is strict liability, and neither scienter or negligence is required.

Criminal Penalties

Case Example 36.11 United States v. Newton (2014)

36-2c Violations of the 1934 Act (slide 2 of 2)

Civil Sanctions

The SEC can bring suit in a federal district court against anyone violating or aiding in a violation of the 1934 act or SEC rules by purchasing or selling a security while in the possession of material nonpublic information.

Private parties may also sue violators of Section 10(b) and Rule 10b-5.

36-2d Online Securities Fraud

Investment Newsletters

An investor may believe that information in an online newsletter is unbiased, when in fact fraudsters will directly profit by convincing investors to buy or sell particular stocks.

Social Media

Anonymous fraudsters can quickly disseminate securities information to millions of people at little or no cost.

It can be difficult for the SEC to access social media accounts to investigate potential violations.

36-3 State Securities Laws

36-3a Requirements under State Securities Laws

State securities laws apply mainly to intrastate transactions.

Case Example 36.11 In re Access Cardiosystems, Inc. (2015)

36-3b Concurrent Regulation

Issuers must comply with both federal and state laws. Most duplicate regulations have been eliminated.

36-4 Corporate Governance

Corporate governance: A set of policies specifying the rights and responsibilities of the various participants in a corporation and spelling out the rules and procedures for making corporate decisions.

36-4a Aligning the Interests of Officers and Shareholders

Problems with Stock Options

Outside Directors

36-4b Promoting Accountability (slide 1 of 2)

At a minimum, corporate governance involves:

Audited reporting of the corporation’s financial progress, so managers can be evaluated.

Legal protections for shareholders, so violators of the law who attempt to take advantage of shareholders can be punished for misbehavior and victims may recover damages for any associated losses.

36-4b Promoting Accountability (slide 2 of 2)

Governance and Corporation Law

State corporation statutes set up the legal framework for corporate governance.

The Board of Directors

The Audit Committee: Oversees the corporation’s accounting and financial reporting processes.

The Compensation Committee: Monitors and determines the compensation of the company’s officers.

36-4c The Sarbanes-Oxley Act

More Internal Controls and Accountability

The act introduced direct federal corporate governance requirements for public companies.

Exemptions for Smaller Companies

Certification and Monitoring Requirements

Section 906: Chief executive officers (CEOs) and chief financial officers (CFOs) must certify that the corporate financial statements “fairly represents in all material respects, the financial conditions and results of operations of the issuer.”

Miller_BLTC12E_PPT_ch36.pptx

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