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That a very important defense for experts such as accountants is the due diligence
defense.
How a due diligence defense is established.
III. Securities Exchange Act of 1934: Being Public (LO 17-3)
Explain:
The role of Securities Exchange Act of 1934 as against that of Securities Exchange Act of
1933.
That the 1934 Act, which created the Securities and Exchange Commission, also deals with
regulation of securities exchanges, brokers, and dealers in securities.
A. Section 10(b) and Rule 10b-5
Emphasize:
That most of the litigation under the Securities and Exchange Act of 1934 is brought
under Section 10(b) of the act and Rule 10b-5 promulgated by the SEC pursuant to the
act.
The clauses stated in Section 10(b) and Rule 10b-5.
The common issues included in Section 10(b) and Rule 10b-5.
Sidebar 17.1—“Language of Section 10(b) of the 1934 Act and the SEC’s Rule 10b–5”
Liability (LO 17-4)
Emphasize:
That there is a limited answer to the question who is liable.
Case 17.1—“Stoneridge Investment Partners, LLC, Petitioner v. Scientific-Atlanta,
Inc., et al.”
Damages
Emphasize:
That a plaintiff in a suit under Rule 10b-5 must prove damages.
That neither punitive damages nor attorney’s fees are recoverable in Section 10(b)
and Rule 10b-5 litigation.
Sidebar 17.2—“Proof of Loss Due to Fraud”
Sidebar 17.3—“Right to Contribution from Others”
Materiality
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Emphasize:
That Section 10(b) and Rule 10b-5 are usually referred to as the antifraud provisions
of the act.
That materiality under the 1934 Act is the same as materiality under the 1933 Act.
How Section 10(b) interprets fraud.
Some difficult issues concerning materiality that affect mergers.
Sidebar 17.4—“Statue of Limitations for Fraud Claims”
Case 17-2—“Morrison v. National Australia Bank LTD”
Additional Matter for Discussion:
A plaintiff alleging damages due to misrepresentations in a registration statement and
prospectus may pursue remedies under Section 10(b) and Rule 10b-5 notwithstanding
that Section 11 of the 1933 Securities Act provides express relief for
misrepresentations in a registration statement or a prospectus. See Herman &
MacLean v. Huddleston, 103 S.Ct. 683 (1983).
Case for Discussion:
1. Basic Incorporated manufactured chemical refractories for the steel industry.
Beginning in September 1976, Combustion Engineering, Inc., held meetings with
officers of Basic, Inc., about the possibilities of a merger. During 1977 and 1978,
Basic made three public statements denying that it was engaged in merger
negotiations. On December 18, 1978, Basic asked the New York Stock Exchange to
suspend trading in its shares and issued a release stating that it had been
“approached” by another company concerning a merger. On December 19, Basic’s
board endorsed Combustion’s offer of $46 per share for its common stock. On the
following day, Basic publicly announced its approval of Combustion’s tender offer
for all outstanding shares.
Former shareholders of Basic, Inc., who sold their stock after the first public
statement filed a suit for damages arguing that Basic, Inc., and its directors issued
false or misleading statements in violation of Section 10(b) of the 1934 Exchange
Act and Rule 10b-5. The defendants argued that announcements about a possible, but
uncertain, merger could not be material as defined by the statute.
Issue: Do Section 10(b) and Rule 10b-5 requirements of materiality apply to
preliminary corporate merger discussions?
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Manipulation and dishonest practices of the marketplace thrive upon mystery and
even though the likelihood of a completed merger is small. Whether merger
discussions in any particular case are material depends on the facts. However, no
particular event or factor need be necessary or sufficient by itself to render merger
discussions material. Basic Incorporated v. Levinson, 108 S.Ct. 978 (1988).
B. Insider Transactions
The reporting requirement of insiders.
Additional Matters for Discussion:
The application of the law to short-swing profits and how it does not matter whether the
purchase or the sale of securities occurs first.
Ask students to provide examples of nonpublic information that may be very valuable to
under Section 10(b) and Rule 10b-5. Section 10(b) has been used to protect investors
from those non-insiders who use nonpublic information in order to manipulate securities
transactions for private gain.
Case 17.3—“United States v. O’Hagan”
The Insider Trading and Securities Fraud Enforcement Act of 1988.
1. Dirks, an investment analyst for a brokerage firm, discovered from a former officer of
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an insurance company that the company’s assets were overstated due to fraudulent
accounting practices. During his investigation, Dirks personally dealt in the insurance
company’s securities. However, he talked about his investigation with his investing
clients. These clients sold their interests before the fraud was publicly announced and
before the insurance company’s securities declined in value. The SEC found that Dirks
had violated Section 10(b) because he, as a tippee, failed to disclose the information
gained from an insider to the public before that information was used to profit in
trading. The court of appeals affirmed the SEC’s findings and censure of Dirks. The
U.S. Supreme Court granted certiorari.
Issue: Was Dirks subject to the 1934 Act?
abstain, it thus is necessary to determine whether or not the insider’s “tip” constituted a
breach of the insider’s fiduciary duty. Whether or not disclosure is a breach of duty
therefore depends largely on the purpose of the insider’s disclosure. The test to be used
is whether or not the insider personally will benefit, directly or indirectly, from his
fiduciary duty, Dirks could not have participated in “passing-on” the insider’s breach of
a fiduciary duty. Therefore, the SEC’s and appellate court’s decisions are reversed.
Dirks v. S.E.C., 103 S.Ct. 3255 (1983).
2. A financial printer has been hired by certain corporations to print corporate-takeover
bids. Chiarella, an employee of the printer, was able to deduce the identities of both the
acquiring companies and the companies which were targeted for takeover. Without
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and his conviction was affirmed by the Second Circuit Court of Appeals.
Issue: Was Chiarella subject to the 1934 Act?
dealt with the sellers only through impersonal market transactions. Chiarella v. United
States, 100 S.Ct. 1108 (1980).
Additional Matters for Discussion:
The SEC has implemented the computerized Market Oversight and Surveillance System
(MOSS) to help locate market irregularities that may indicate trading with nonpublic
information.
That there is a dispute as to whether or not trading with nonpublic information hurts
markets. Are small investors worth protecting?
The Ivan Boesky, Drexel Burnham Lambert, Inc., and Michael Milken cases? Were their
punishments appropriate?
D. Additional Civil Liability
Emphasize:
The Securities Enforcement Remedies Act of 1990 and the increased civil sanctions.
1933 Act.
Table 17.3—“Largest Securities Class-Action Settlements (2005-2007)”
Additional Matter for Discussion
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Additional Matter for Discussion:
specifically stated in the private party’s complaint.
The purpose of enacting the Securities Litigation Uniform Standards Act of 1998
(SLUSA).
The limitation on damages that a private party can recover and restriction on attorneys
fee that can be collected.
The term blue sky laws.
The various applications of blue sky laws and their relation to federal regulations.
The reason for the enactment of the Uniform Securities Act, 1956.
Registration Requirements
Emphasize:
The various exemptions by giving examples of each.
Additional Matters for Discussion:
The type of law enacted in each state and any exemptions provided by the law.
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The example at the end of the section on “any 12-month period.”
Emphasize:
The main function of the Sarbanes-Oxley Act of 2002.
The history of corruption related to corporations such as Enron, WorldCom, Tyco,
Adelphi, Health South, and Arthur Andersen.
The proposed increase in the SEC’s budget and how this has become a battleground
B. Accounting Reforms
Emphasize:
The role of the Public Company Accounting Oversight Board (PCAOB).
The organizational structure of the PCAOB within the SEC as opposed to it being an
independent agency.
Emphasize:
The importance of this part of Sarbanes-Oxley as being the law’s lasting contribution.
That Sarbanes-Oxley focuses on increasing the independence of the auditors.
The requirement of at least one member with knowledge of GAAP.