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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.
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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.
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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
