978-0134004006 Chapter 41 Lecture Note Part 2

Unlock access to all the studying documents.

View Full Document

Chapter 41

340

Circuit

Facts: Upon receiving news that Nvidea had been awarded the contract to develop a video game

console for Microsoft Corporation, Nvidea’s Chief Executive Officer (CEO) sent a company–

wide e-mail late Sunday night announcing the contract award. The next morning, Nvidea sent a

number of follow-up e-mails advising Nvidea employees that the X-box information should be

kept confidential and imposing a trading blackout on the purchase of Nvidea stock by employees

purchased Nvidea stock. Bhagat denied telling anyone about the X-box contract before the

information was made public. There was no direct evidence that Bhagat contacted Gill prior to

Gill’s purchase of Nvidea stock. The Securities and Exchange Commission (SEC) investigated

Bhagat’s and Gill’s purchases of Nvidea stock. Subsequently, the United States brought criminal

charges against Bhagat charging him with insider trading, tipping, and obstructing an SEC

investigation?

Decision: Yes. The U.S. Court of Appeals upheld the U.S. district court’s judgment finding

Bhagat criminally guilty of insider trading, tipping, and obstructing the SEC’s investigation. The

U.S. Court of Appeals remanded the case to the U.S. District Court for sentencing of Bhagat. To

convict Bhagat of insider trading, the government was required to prove that he traded stock on

the basis of material, nonpublic information. The government offered significant evidence to

conducting a proceeding; that the defendant was aware of that proceeding; and that the defendant

intentionally interfered with, or obstructed the course of, that proceeding.

Ethics Questions: Insider trading occurs when a company employee or company advisor uses

material nonpublic information to make a profit by trading in the securities of the company. This

practice is considered illegal because it allows insiders to take advantage of the investing public.

Case 41.2 Tipper-Tippee Liability: United States v. Kluger

722 F.3d 549, 2013 U.S. App. Lexis 13880 (2013), United States Court of Appeals for the Third

Circuit

Facts: Three men (white-collar professionals) were engaged in an insider-trading ring which

yielded almost $50 million in profits. All three men were convicted and one, Kluger, received a

Investor Protection and E-Security Transactions

341

Misappropriation Theory – This rule involves outsiders that have misappropriated information

in violation of their fiduciary duty.

Aiders and Abettors – These people knowingly assist persons in completion of a securities

fraud.

Ethics: Stop Trading on Congressional Knowledge Act

Short-Swing Profits

Section 16(a) defines insiders as any executive officers, directors, or ten percent shareholders

Section 16(b) – Profits from trades involving securities occurring within six months of each other

belong to the company.

State “Blue–Sky” Laws

Most states have enacted blue-sky laws, which require the registration of certain securities, while

exempting others.

V. Key Terms and Concepts

securities fraud.

 Annual report—A report which is required to be filed by public companies.

 Blue Sky laws—State securities laws.

 Civil action—Private parties who have been injured by certain registration statement

violations by an issuer or others may bring a civil action against the violator under Section 11

of the Securities Act of 1933.

exceed nine months.

Chapter 41

342

common securities.

 Confidential draft registration statement—An EGC may submit this to the SEC for review. If

 Consent decree—The SEC may issue a consent decree whereby a defendant agrees not to

violate securities laws in the future but does not admit to having violated securities laws in

the past.

movements of another asset.

 Doff-Frank Wall Street Reform and Consumer Protection Act—A 2010 federal statute that

 Due diligence defense—A defense to a Section 11 action that, if proven, makes the defendant

not liable.

Internet.

 Electronic securities transactions—Electronic securities transactions, or e-securities

 EDGAR—The electronic data and record system of the Securities and Exchange Commission

(SEC).

bond offering.

 Exempt securities—Securities that are exempt from registration with the SEC.

 Exempt transactions—Certain transactions where securities are sold are exempt from

registration with the SEC if they meet specified requirements.

 Form U-7—The SCOR form, Form U-7, is a question-and-answer disclosure form that small

businesses can complete and file with the SEC if they plan on raising $1 million or less from

the public issue of securities.

wealthy investors.

 Howey test—A test which states that an arrangement is an investment contract if there is an

 Injunction—The SEC may bring an action in U.S. District Court to obtain an injunction to

stop challenged conduct.

Investor Protection and E-Security Transactions

343

by the company on a temporary and nonemployee basis to provide services or work to the

 Intrastate offering exemption—An exemption from registration that permits local businesses

 Investment banker—Many issuers of securities employ investment bankers, which are

independent securities companies, to sell their securities to the public.

Sarbanes-Oxley requirements for start up companies.

 Matter of Cady, Roberts & Company—In the Matter of Cady, Roberts & Company, the SEC

announced that the duty of an insider who possesses material nonpublic information is to

for the long-term, and are restricted from investing in risky investments.

 National Association of Securities Dealers Automated Quotation System—NASDAQ is the

world’s largest electronic securities exchange. It lists more than 3,500 U.S. and global

companies and corporations.

 New York Stock Exchange—The NYSE lists the stocks and securities of approximately

3,000 of world’s largest companies for trading.

requirements of being an accredited investor.

 Non-issuer exemption—An exemption from registration which states that securities

 NYSE Euronext—The New York Stock Exchange (NYSE) is operated by NYSE Euronext,

which was formed when the NYSE merged with the fully electronic stock exchange

Euronext.

investor under a Reg A filing.

Chapter 41

344

deals below.

 Prospectus—A written disclosure document that must be submitted to the SEC along with the

 Registration statement—Document that an issuer of securities files with the SEC that

registration process.

 Reporting companies—Companies that must file periodic statements with the SEC.

 Rules—Adopting rules (also called regulations) that further the purpose of the federal

securities statutes is a responsibility of the SEC.

and Rule 10b-5.

 SEC Rule 10(b)-5—A rule adopted by the SEC to clarify the reach of Section 10(b) against

deceptive and fraudulent activities in the purchase and sale of securities.

 SEC Rule 10(b)5-1—An SEC rule that prohibits the trading in the security of any issuer on

the basis of material nonpublic information obtained in a breach of duty of trust or confidence

owed to the person who is the source of the information.

securities laws and registrations.

 SEC Rule 504—An exemption from registration that permits the sale of securities not

exceeding $1 million during a twelve-month period. Also known as SEC Rule 504.

 SEC Rule 506—An exemption from registration that permits issuers to raise capital from an

unlimited number of accredited investors and no more than thirty-five nonaccredited

investors without having to register the offering with the SEC.

securities advice functions of securities firms.

 Section 5 of the Securities Act of 1933—A section that requires an issuer to register its

 Section 11 of the Securities Act of 1933—A provision of the Securities Act of 1933 that

imposes civil liability on persons who intentionally defraud investors by making

regulations adopted thereunder.

 Section 10(b) of the Securities Exchange Act of 1934—A provision of the Securities

Exchange Act of 1934 that prohibits the use of manipulative and deceptive devices in the

Investor Protection and E-Security Transactions

345

SEC.

 Section 16(a) of the Securities Exchange Act of 1934—A section of the Securities Exchange

 Section 16(b) of the Securities Exchange Act of 1934—A section of the Securities Exchange

corporations, partnerships, associations, and individuals.

 Securities and Exchange Commission (SEC)—Federal administrative agency that is

 Securities Exchange Act of 1934—A federal statute that primarily regulates the trading in

securities.

acts, and (3) an investment contract.

 Short-swing profits—Profits that are made by statutory insiders on trades involving equity

 SCOR—A method for small companies to sell up to $1 million of securities to the public by

 State securities laws—State laws that regulate the issuance and trading of securities.

securities acts are statutorily defined securities.

 Tippee—The person who receives material nonpublic information from a tipper.

 Tipper—A person who discloses material nonpublic information to another person.

 Tipper-tippee liability—The tipper is liable for the profits made by the tippee.

 Uniform Securities Act—The Uniform Securities Act has been adopted by many states. This

act coordinates state securities laws with federal securities laws.

unlawful.

 Well-known seasoned investor—For particular publicly traded companies, the SEC permits