B-Law Chapter 28

What must a defendant prove to avoid liability under the 1933 act?

A defendant can avoid liability under the 1933 Act by proving one or more of the following: Immateriality Plaintiff's Knowledge Due Diligence

What will result from a violation of the 1933 Act's registration requirements?

Any violation of the 1933 Act's registration requirements or any material misrepresentation or omission in a registration statement or prospectus may result in civil - and, if the violation was willful, criminal - liability.

What are the basic functions of the SEC?

Basic Functions of the SEC: (1) requiring disclosure of facts concerning offerings of securities to the public; (2) regulating the trade in securities on national and regional securities exchanges and in the over-the-counter ("OTC") markets; (3) investigating securities fraud; (4) registering and regulating the activities of securities brokers, dealers, and investment advisers; (5) supervising mutual funds; and (6) recommending administrative sanctions, injunctions, and criminal prosecution for violations of federal securities laws.

How has the Sarbanes-Oxley Act imposed stricter disclosure requirements and harsher penalties for violations of federal securities law?

Chief corporate executives are now personally responsible for the accuracy of financial statements and reports filed with the SEC; Certain financial and stock transaction reports must be filed with the SEC earlier than before; The Act created the Public Company Accounting Oversight Board to regulate public accounting firms.

What are the minimums for good corporate governance?

Good corporate governance involves, at a minimum, auditing financial statements legal protections for shareholders

What does good corporate governance standards aim to do?

Good corporate governance standards aim to motivate officers to make decisions that subordinate (to the extent that they diverge) their own financial interests to those of the corporation's shareholders; and motivate directors to effectively monitor the corporation's officers, compensate officers in a manner that better aligns the officers' interests with those of the corporation's shareholders, and take prompt remedial steps when one or more officers appear to be pursuing a course of action that is not in the shareholders' best interest.

What are some exempt securities?

Securities issued or guaranteed by the federal government, a state or local government, or any public instrumentality; Securities issued by a bank, savings institution, trust company, farmers' cooperative, or similar institutions subject to government supervision; Insurance, endowment, pension, or annuity contracts issued by a state-regulated insurance company; Commercial paper maturing in nine months or less; Securities issued by charitable organizations; Certificates issued by trustees, receivers, or debtors-in-possession under the bankruptcy laws; Securities issued exclusively for exchange for securities held by the issuer's pre-existing security holders; Securities offered and sold only to persons within a single state by an issuer who is a resident of that state; and At the SEC's discretion, securities not subject to any other exemption that are offered by any issuer offering $5 million or less worth of securities during a 12-month period (Regulation A offerings)

What are some transactions exempted by statute?

Transactions by any person other than an issuer, underwriter, or dealer; Private offering transactions by an issuer; Transactions by a dealer, more than forty days after the effective date of a registration statement, if any; or the first date upon which the security was bona fide offered to the public by the issuer or by or through an underwriter after such effective date, whichever is later; unless the securities are part of an unsold allotment to or subscription by such dealer as a participant in the distribution; Unsolicited brokers' transactions; and Section 4(6): Offerings of up to $5 million per year made solely to accredited investors, provided that there is no advertising or public solicitation in connection with the transaction by the issuer or anyone acting on the issuer's behalf.

What is a Ponzi scheme?

A form of fraud in which belief in the success of a nonexistent enterprise is fostered by the payment of quick returns to the first investors from money invested by later investors.

What does Rule 10b-5 do?

An SEC rule making it unlawful, in connection with the purchase or sale of any security, to (1) make any untrue statement of a material fact or (2) omit a material fact, if such omission causes the statement to be misleading.

What is the Securities and Exchange Commission (SEC)?

An independent regulatory agency, created by the Securities Exchange Act of 1934, and empowered to enforce the various federal securities laws and to promulgate regulations to aid in their enforcement.

What is an investment contract?

Any transaction in which a person (1) invests (by purchasing stock, a bond, or other security) (2) in a common enterprise, (3) from which she reasonably expects to earn profits (4) primarily or substantially as a result of the managerial or entrepreneurial efforts of others.

Who can be liable for insider trading?

Anyone who acquires inside information as a result of a corporate insider's breach of his fiduciary duty to the corporation - even tippees, who are not "insiders," but who receive inside information from an insider - can be liable under Rule 10b-5 for insider trading.

What is misappropriation?

Anyone who wrongfully obtains inside information and trades on it for her own personal gain can, likewise, be liable under Rule 10b-5 for insider trading.

What is "security"?

Both the Securities Act of 1933 and the Securities Exchange Act of 1934 define a "security" as: any note, stock, treasury stock, bond, debenture, evidence of indebtedness, certificate of interest or participation in any profit-sharing agreement, ... investment contract, ... option, ... or, in general, any interest or instrument commonly known as a "security," or any certificate of interest or participation in, temporary or interim certificate for, receipt for, guarantee of, or warrant or right to subscribe to or purchase, any of the foregoing.

Where is effective corporate governance most important?

Effective corporate governance is particularly important to publicly-traded corporations where ownership (by shareholders) is separated from corporate control (by directors and officers).

How can the plaintiff's knowledge be used as a defense?

Even if the defendant made a false or misleading statement or omission, the plaintiff knew about the misrepresentation or omission and bought the stock anyway

How can immateriality be used as a defense?

Even if the defendant made a false or misleading statement or omission, the statement or omission was not material

What is "blue sky" law?

Every state has its own securities law (a.k.a. "blue sky" law) that regulates the offer and sale of securities within a state, to or from the state, and to or by a citizen of the state.

What is materiality?

Examples of facts that a seller or buyer of securities must truthfully disclose to avoid liability under Rule 10b-5, if the undisclosed or misrepresented fact is likely to affect the other party's decision to buy or sell the securities, include: significant changes in the corporation's financial condition; developments, such as a new discovery or the prospect of litigation, that will likely cause significant changes in the corporation's financial condition; and fraudulent trading in the corporation's securities by a broker-dealer, a corporate insider or tippee, or anyone else likely to significantly affect the market's perception of the corporation's securities.

How can a tippee be liable?

In order for a tippee to be liable, she must: (1) receive inside information, (2) which was disclosed, in exchange for some personal benefit to a corporate insider (the tipper), (3) as a result of the tipper's breach of his fiduciary duty to the corporation, (4) of which breach the tippee knows or should know, and (5) from which breach the tippee benefits financially.

What does Section 10(b) of the 1934 Act prohibit? What does it not do?

Section 10(b) of the 1934 Act prohibits the use of "any manipulative or deceptive" statement, instrument, or the like in an attempt to contravene the rules and regulations set forth by the SEC. Section 10(b) does not explicitly provide a cause of action for an injured plaintiff. Courts have read an implied private cause of action into Rule 10b-5.

What is insider reporting?

Section 12 of the 1934 Act requires that all officers, directors, and shareholders owning 10 percent or more of any class of a corporation's stock file periodic reports with the SEC reflecting their ownership of and trading in the corporation's securities.

What kind of sanctions does Section 16(b) of the 1934 Act allow?

Section 16(b) of the 1934 Act allows the corporation to "recapture" any profits realized by an insider on any sale and purchase or purchase and sale of the corporation's stock, warrants, options, or other securities that can be converted into stock within any six-month period - regardless of whether the insider's trading was a result of any "inside information."

What does Section 5 of the Securities Act state?

Section 5 of the Securities Act requires that, subject to certain exemptions, a security must be registered before it is offered for sale to the public either through the mails or other facility of interstate commerce, including stock exchanges.

What do the the Insider Trading Sanctions Act of 1984 and the Insider Trading and Securities Fraud Enforcement Act of 1988

The Insider Trading Sanctions Act of 1984 and the Insider Trading and Securities Fraud Enforcement Act of 1988 give the SEC broad powers to bring civil suit against insiders and others who use inside information for their own benefit.

What is "Safe Harbor"?

The Private Securities Litigation Reform Act of 1995 protects financial forecasts and other "forward-looking" statements from giving rise to liability under Section 10(b) and Rule 10b-5, provided that "meaningful cautionary statements" accompany the "forward-looking" statement.

What does the Securities Exchange Act of 1934 regulate?

The Securities Exchange Act of 1934 regulates securities exchanges, brokers, dealers, and national securities associations, as well as all corporations (1) whose stock is listed on a stock exchange or (2) which have assets in excess of $10 million and five hundred or more shareholders.

What does the Securities Litigation Uniform Standards Act of 1998 do?

The Securities Litigation Uniform Standards Act of 1998 placed limits on plaintiffs' abilities to bring class-action lawsuits in state courts against firms traded on a national stock exchange.

How can due diligence be used as a defense?

The defendant (other than an issuer) reasonably believed, at the time the registration statement became effective, that the statements it contained were true and there were no omissions of material fact.

What must the registration statement of the issuer of a nonexempt security say?

The issuer of a nonexempt security - unless the issuing transaction itself is exempt - must file with the SEC a registration statement, which must describe (1) the significant characteristics of the offered security, including its relationship to the issuer's other outstanding securities, (2) the issuer's properties and business activities, including a financial statement certified by an independent accounting firm, (3) the issuer's directors and officers, their compensation, securities holdings, and other benefits, and any interest in any material transactions, and (4) how the issuer intends to use the proceeds from the sale of the offered security, (5) any pending lawsuits or special risk factors.

What is a main factor in liability under Rule 10b-5?

The key to liability under Rule 10b-5 is whether the untrue statement or omission concerns a material fact.

What is the Sarbanes-Oxley Act?

The most significant recent statutory change to the federal securities regulatory regime was the passage in 2002 of the Sarbanes-Oxley Act, a far-reaching attempt to increase corporate accountability - and, in turn, restore investor confidence shaken by a series of major scandals - by imposing stricter disclosure requirements and harsher penalties for violations of federal securities law.

What is corporate governance?

The policies and procedures that specify the rights and responsibilities of a corporation, its directors, officer, shareholders, and other stakeholders.

What is insider trading?

The purchase or sale of securities on the basis of information that is not publicly available.