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CHAPTER 7: SECURITIES LAW AND CORPORATE GOVERNANCE 11
whole or in part.
Blackstone raised more than $4.5 billion through the IPO. Blackstone officers received nearly all
of the net proceeds. If the company had disclosed the omitted information in its registration
statement, how might these results have been different? Informed investors would probably not have
been willing to pay the same price for shares of Blackstone’s stock as they paid without the omitted
information. Thus, most likely, the amount of capital raised through the IPO would have been less, and the
Litwin alleged that Blackstone had negligently omitted material information from the registration
statement. What will he and the others have to show to prove their case? To succeed in a negligence
action, the plaintiffs must prove that (1) the defendants owed a duty of care to the plaintiffs, (2) the defendants
breached that duty, (3) the defendants’ breach caused injury to the plaintiffs, and (4) the plaintiffs suffered a
ANSWER TO “THE ECONOMIC DIMENSION”
QUESTION IN CASE 7.1
Blackstone raised more than $4.5 billion through the IPO. Blackstone officers received nearly all
III. The Securities Exchange Act of 1934
The Securities Exchange Act of 1934 concerns primarily the resale of securities, requiring continuous,
periodic disclosure, under Section 12, by all corporations with securities on the exchanges and those
companies that have assets in excess of $10 million and five hundred or more shareholders.
whole or in part.
Section 10(b) and Rule 10b-5 prohibit fraud in connection with the purchase or sale of a security. Rule
10b-5 applies to virtually all securities transactions. The elements of a securities fraud action are—
ENHANCING YOUR LECTURE—
CORPORATE BLOGS AND TWEETS MUST COMPLY
WITH THE SECURITIES AND EXCHANGE ACT
regulations. The SEC treats statements by employees on online media, such as blogs and Twitter, the same
as any other company statements for purposes of federal securities laws.
BEWARE OF TWEETS CONTAINING FINANCIAL INFORMATION
problems with the SEC. Many of his former audience were disappointed by the company’s oversight, which
put an end to his spontaneous, personal, and informal style. Brewer-Hay is now much more reserved in his
tweets on financial matters and often simply repeats eBay executives’ statements verbatim.a
A 2008 SEC RELEASE PROVIDES GUIDANCE
The release also addressed company-sponsored blogs, electronic shareholders’ forums, and other
“interactive Web site features.” The SEC acknowledged that blogs and other interactive Web features are a
useful means of ongoing communications among companies, their clients, investors, shareholders, and
CHAPTER 7: SECURITIES LAW AND CORPORATE GOVERNANCE 13
whole or in part.
subject to the antifraud provisions of federal securities laws. “While blogs or forums can be informal and
conversational in nature, statements made there . . . will not be treated differently from other company
statements.” In addition, the release stated that companies cannot require investors to waive protections
under federal securities laws as condition of participating in a blog or forum. (The release also cautioned
companies that they can, in some situations, be liable for providing hyperlinks to third party information or
a. Cari Tuna, “Corporate Blogs and ‘Tweets’ Must Keep SEC in Mind,”, online.wsj.com, April 27, 2009. Web.
b. SEC Release Nos. 34–58288, IC–28351, File No. S7–23–08. Commission Guidance on the Use of Company Web Sites.
A key to liability is whether inside information is material. Facts to be disclosed include—
• Fraudulent trading in the company’s stock.
• A dividend change (up or down).
• A contract for the sale of corporate assets.
Case 7.2: SEC v. Texas Gulf Sulphur Co.
The Texas Gulf Sulphur Co. (TGS) drilled a hole in 1963 that appeared to yield a core with an ex-
ceedingly high mineral content. Keeping this secret, TGS officers, directors, and employees made substantial
The U.S. Court of Appeals for the Second Circuit reversed and remanded. The test of “materiality” is
whether the information would affect the judgment of reasonable investors. An important factor in determining
whether the discovery of ore is a material fact is the importance attached to it by those who know of it. Stock
14 INSTRUCTOR’S MANUAL FOR BUSINESS LAW: COMMERCIAL LAW FOR ACCOUNTANTS
whole or in part.
by the information.
..................................................................................................................................................
Notes and Questions
industry should be barred from purchasing stocks simply because they have developed an expertise about
that industry that enables them to make profitable investments. Should higher-level company officers as
well as directors be prohibited from holding company stock altogether to eliminate much of the
incentive to engage in insider trading? Because most officers and directors do not engage in insider
trading, such a proposal would probably not be helpful.
to TGS, instead of playing down the drilling results, would the defendants have avoided liability?
Explain. Probably not. While revealing such news might have been “fairer” to the public, TGS officers,
directors, and employees still had material information the would affect the judgment of reasonable investors.
That information was not released in a timely manner.
stock without concern for liability if he or she—after the decision was made to buy or sell the stock—comes
into the possession of inside information relating to that stock.
is most probably yes, because the defendants’ trading was based on their possession of inside information of
a material fact without its public disclosure, which is a violation of SEC Rule 10b-5. Depending on subsequent
CHAPTER 7: SECURITIES LAW AND CORPORATE GOVERNANCE 15
ADDITIONAL BACKGROUND—
officers with inside information could trade with impunity without disclosing the information (as long as they
avoided outright fraud). Although this rule is sometimes stated to be the majority rule, it has been applied in
few cases over the last ninety years. Instead, the courts have developed a number of “exceptions.” Some
state courts have developed an agency law theory. According to agency law, an agent may not profit from
using the property of his or her principal. It is reasoned by analogy that a director or officer may not profit from
way, there should be no conclusion of wrongdoing. Do your students agree with this contention? Does
insider trading in the stock of a corporation do no harm to the corporation? In Diamond v. Oreamuno,
24 N.Y.2d 494, 248 N.E.2d 910, 301 N.Y.S.2d 78 (1969), the court pointed out that, “despite the lack of any
specific allegation of damage, it may well be inferred that the defendants’ actions might have caused some
harm to the enterprise. Although the corporation may have little concern with the day-to-day transactions in its
stockholders.’”
3. Outsiders and SEC Rule 10b-5
Section 10(b) and Rule 10b-5 covers certain “outsiders” (those who trade on inside information ac-
16 INSTRUCTOR’S MANUAL FOR BUSINESS LAW: COMMERCIAL LAW FOR ACCOUNTANTS
CHAPTER 7: SECURITIES LAW AND CORPORATE GOVERNANCE 17
ADDITIONAL BACKGROUND—
Misappropriation Theory—United States v. Carpenter
then buy or sell stock based on the probable impact of the column on the market and share the resulting
profits. David Carpenter, a news clerk at the Journal, also participated in the scheme, acting primarily as a
messenger between the conspirators. Over a four-month period, the net profits resulting from this trading
activity were about $690,000. Correlations between the “Heard on the Street” articles and trading in the Clark
account were noted at Kidder Peabody, and inquiries began. Later, the SEC began an investigation.
In United States v. Carpenter, 791 F.2d 1024 (2d Cir. 1986), the U.S. Court of Appeals for the Second
Circuit upheld the convictions of the defendants, ruling that the defendants had violated insider-trading laws
by trading to their profit on the basis of information obtained by Winans in violation of his duty to his employer
to keep the information confidential. The court brushed aside the defendant’s argument that the
4. Insider Reporting and Trading—Section 16(b)
Section 16(b) provides for the recapture by a corporation of all profits realized by officers, directors,
and certain large stockholders of Section 12 corporations on any purchase and sale or sale and
purchase of the corporation’s stock within any six-month period. It is irrelevant whether the insider
18 INSTRUCTOR’S MANUAL FOR BUSINESS LAW: COMMERCIAL LAW FOR ACCOUNTANTS
whole or in part.
B. REGULATION OF PROXY STATEMENTS
Section 14(a) of the 1934 act regulates management’s solicitation of proxies from shareholders of
Section 12 companies. There must be full and accurate disclosure. SEC Rule 14a-9 is similar to the
antifraud provisions of Rule 10b-5. Remedies for violation range from enjoining a shareholder vote to
1. Scienter Requirement
Section 10(b) and Rule 10b-5 require proof of an intent to defraud or knowledge of the
misconduct—false statements, a wrongful failure to disclose material facts, or recklessness as to
the truth or falsity of statements.
Between May 4 and June 22, 2009, Boeing Co. made announcements that implied its Dreamliner, which
had not yet flown, was on track for its “First Flight” (a significant milestone in the development of new aircraft)
scheduled for June 30. Meanwhile, however, the plane failed important stress tests—before and after
redesign—and on June 23, Boeing canceled the scheduled flight. This presaged a delay in the delivery of the
Dreamliner to the airlines. Boeing’s stock price dropped more than 10 percent. On behalf of all persons who
..................................................................................................................................................
Notes and Questions
CHAPTER 7: SECURITIES LAW AND CORPORATE GOVERNANCE 19
whole or in part.
Initial pleadings are comprised of a complaint, a summons, and an answer. The pleading at the center of the
dispute in the City of Livonia case was the plaintiffs’ complaint.
The plaintiffs in this case consisted of persons who bought stock in the Boeing Co. between the tests of
its new 787–8 Dreamliner and the announcements of the cancellation and of the delay in delivery and who
the plaintiff must state facts giving rise to a strong inference of scienter at least as likely as any plausible
opposing inference.
The complaint in the City of Livonia case alleged violations of Section 10(b) and Rule 10b-5. The plaintiffs
claimed that Boeing Co. and its officers, James McNerney and Scott Carson, knew about the likely
Livonia case, the court concluded that the plaintiff’s complaint did not meet the requirement that a complaint
alleging violations of Section 10(b) of the Securities Exchange Act of 1934 and SEC Rule 10b-5, the plaintiff
must state facts giving rise to a strong inference of scienter at least as likely as any plausible opposing
inference.
On the plaintiffs’ appeal, the U.S. Court of Appeals for the Seventh Circuit affirmed the dismissal. The
appellate court explained that “allegations * * * merely implying unnamed confidential sources of damaging
information require a heavy discount. The sources may be ill-informed, may be acting from spite rather than
knowledge, may be misrepresented, may even be nonexistent.” The court reasoned that the defendants had
20 INSTRUCTOR’S MANUAL FOR BUSINESS LAW: COMMERCIAL LAW FOR ACCOUNTANTS
whole or in part.
In the City of Livonia case, the plaintiffs alleged in their complaint that Boeing Co. and its officers, James
McNerney and Scott Carson, knew about the likely postponement of the First Flight of the company’s new
Dreamliner aircraft, even when those officers made public statements to the contrary. The plaintiffs asserted
that their allegations were confirmed by “internal e-mails” at Boeing, implying that someone inside the
confidential sources, which the court suggested the lawyers might have made to prevent the dismissal of their
case or to have prompted further discovery and thereby encourage the defendants to settle. The court
suggested that those sanctions should consist of a fine, but deferred to the lower court for the amount. That
court “may have additional insights into the accused lawyers' conduct, by virtue of having spent more time on
the litigation than the appellate court.”
• Halperin v. EBanker USA.com, Inc., 295 F.3d 352 (2d Cir. 2002) (in investors’ action against three
corporations and several officers and directors, alleging that the defendants fraudulently misrepresented the
future registration of certain securities, the securities’ offerings did not contain material omissions—”[a]n
offeror is not liable for securities fraud simply because the investment did not turn out as the investor hoped”).
public forecasts that were materially false and misleading).
• In re Enron Corp. Securities, Derivative & ERISA Litigation, 235 F.Supp.2d 549 (S.D.Tex. 2002)
(investors stated claims, or failed to state claims, in securities fraud actions against Enron Corp., as well as
individual executives, attorneys, accountants, banks, and others, alleging elaborate and large-scale Ponzi
