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Chapter 41
Investor Protection and E-Securities Transactions
VI. Answers to Critical Legal Thinking Cases
41.1 Definition of a Security
The notes issued by the Co-Op are “securities.” In order for the defendant, Ernst & Young, to be subject
to federal securities laws in this case, the instrument at issue must be found to be a security. The U.S.
Supreme Court found the note issued by the Co-Op to be a security, thus subjecting the Co-Op’s auditor,
Ernst & Young, to a securities lawsuit. The Supreme Court applied a “family resemblance test” in finding
41.2 Definition of Security
Yes, the Dare sales scheme is a security that should have been registered with the Securities and
that the Dare multilevel sales scheme was an investment contract. There was obviously an investment of
money in a common enterprise. The only difficult issue was whether the Dare plan derived profits for the
the Adventure levels. The court held that the Dare multilevel sales scheme was an “investment contract”
and therefore a security that had to be registered with the SEC before it was sold. The court held that
Ninth Circuit)
41.3 Intrastate Offering Exemption
No, the issue of securities by McDonald Investment Company (McDonald) does not qualify for the
derived from within the state; and (4) the purchasers of the securities were all residents of the state.
However, to qualify for the exemption, at least 80 percent of the proceeds from the offering must be
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Minnesota)
41.4 Transaction Exemption
No, the sale of the Continental securities by Wolfson and his family and associates does not qualify for an
exemption from registration as a sale “not by an issuer, underwriter, or dealer.” The court held that an
issuer includes any person who directly or indirectly controls the issuer. In this case, Wolfson controlled
Continental. He was its largest shareholder, made the policy decisions for the corporation, and controlled
41.5 Section 10(b)
The plaintiff investors win and may sue the defendants for the alleged violations of Section 10(b) of the
Securities Exchange Act of 1934. The defendants had asserted that the common–law defense of in pari
delicto (“unclean hands”) prohibited the plaintiffs from suing because they had participated in the fraud
with the defendants, i.e., the plaintiffs thought they were trading on “inside information” when they
purchased the TONM securities. Under the in pari delicto theory, if two parties to illegal conduct are
mutually or equally at fault, they cannot use the court system to sue the other party to the illegal conduct.
broker dealers to full public view for appropriate sanctions.” The court held that the in pari delicto theory
did not apply to suits alleging violations of Section 10(b) and that the plaintiffs could maintain their
41.6 Insider Trading
Crawford sought to, and did, “beat the news.” Before insiders may act upon material information, such
information must have been effectively disclosed in a manner sufficient to ensure its availability to the
investing public. Here, where a formal announcement to the entire financial news media had been
promised in a prior official release known to the media, all insider activity must await dissemination of
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of, and in frustration of, the objectives of the release. Assuming that the contents of the official release
could instantaneously be acted upon, at a minimum, Coates should have waited until the news could
reasonably have been expected to appear over the media of widest circulation, rather than hastening to
ensure an advantage to himself and his broker son-in-law. Both Crawford and Coates, insider executives
VII. Answer to Ethics Case
41.7 Ethics Case
classic outsider to which the misappropriation theory applies. O’Hagan was a lawyer hired by one
company, Grand Metropolitan PLC (Grand Met), to prepare documents for the possible tender offer by
Grand Met for the shares of Pillsbury Company. O’Hagan used the inside information he knew about the
tender offer and purchased shares and options on Pillsbury stock. O’Hagan made a profit of more than $4
conduct had not been made illegal. But the U.S. Supreme Court, in applying the misappropriation theory,