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in whole or in part.
ANSWERS TO QUESTIONS
AT THE ENDS OF THE CASES
CASE 7.1—QUESTION (PAGE 119)
THE LEGAL ENVIRONMENT DIMENSION
omissions are proved to be material, their nondisclosure in the registration statement is a breach
of the duty. Presumably, the plaintiffs’ injury consists of losses due to the impact of Blackstone’s
investments in FGIC and Freescale on the price of its securities.
THE ECONOMIC DIMENSION
have likewise been less.
CASE 7.2—QUESTION (PAGE 121)
WHAT IF THE FACTS WERE DIFFERENT?
in whole or in part.
CHAPTER 7: SECURITIES LAW AND CORPORATE GOVERNANCE 3
in whole or in part.
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 no motive to commit securities
fraud—they had nothing to gain by delaying the announcement of the First Flight’s
postponement. The court concluded that “a more plausible inference than that of fraud is that
the defendants, unsure whether they could fix the problem by the end of June, were reluctant to
tell the world ‘we have a problem and maybe it will cause us to delay the First Flight and maybe
not, but we're working on the problem and we hope we can fix it in time to prevent any
significant delay, but we can't be sure, so stay tuned.’ ”
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 company was helping their case.
But the plaintiffs did not identify their source. The lower court then refused to give any weight to
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.”
have been required to register with the SEC.
4 UNIT ONE: BUSINESS ORGANIZATIONS
© 2015 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website,
in whole or in part.
2A. Securities laws
Emerson did not fail to disclose a material fact in connection with the purchase or sale of
securities. What he did do was use bad judgment and breach a fiduciary duty by mentioning the
planned takeover to his uncle, who then took the information and used it to his advantage.
There is no indication in the facts that Emerson intended to do anything wrong or knew that his
uncle would use this information to trade on the information (that he should not have disclosed).
3A. Insider trading theory
required to certify the financial statements.
ANSWER TO DEBATE THIS QUESTION IN THE REVIEWING FEATURE
AT THE END OF THE CHAPTER
Laws against insider trading were put in place to prevent insiders—usually highly paid
upper-level managers—from undeservedly benefiting from their positions in the publicly head
companies. If insider trading were no longer illegal, insiders would stand to make fortunes from
buying the companies’ stock before good news is released. If the inside news is bad, insiders
can make fortunes selling short the companies’ stocks.
Specifically, the law imposes liability for making a false statement or omission that is
“material.” What sort of information would an investor consider material? The average
investor is not concerned with minor inaccuracies but with facts that if disclosed would tend to
deter him or her from buying the securities. This would include facts that have an important
CHAPTER 7: SECURITIES LAW AND CORPORATE GOVERNANCE 5
in whole or in part.
bearing on the condition of the issuer and its business—liabilities, loans to officers and directors,
2A. Lee is an officer of Magma Oil, Inc. Lee knows that a Magma geologist has just
discovered a new deposit of oil. Can Lee take advantage of this information to buy and
sell Magma stock? Why or why not? No. The Securities Exchange Act of 1934 extends
liability to officers and directors in their personal transactions for taking advantage of inside
(Chapter 7—Page 114)
Gustavo is right. Under Section 3(a)(11) of the Securities Act of 1933, stock offerings that are
restricted to residents of the state in which the issuing company is organized and doing
business are exempt from registration requirements. Therefore, the Estrada Hermanos offering
need not be registered with the SEC. The offering will, however, be subject to state securities
because no sale of stock is involved. The existing shares are merely being split, and no
consideration is received by the corporation for the additional shares created.
7–3A. Insider trading
(Chapter 7—Page 120)
can be established when it can be inferred that the most likely source of that belief was an
insider. For example, a stock purchase or sale’s proximity in time to a phone conversation
between a trader and one with inside information provides a reasonable basis for inferring an
exchange of that information. Thus, in this problem, on this basis, a court could hold David liable
for insider trading.
CHAPTER 7: SECURITIES LAW AND CORPORATE GOVERNANCE 7
in whole or in part.
that reasonable investors would have viewed this information as material. Zicam products
account for 70 percent of Matrixx’s sales. Matrixx received reports of consumers who suffered
anosmia after using Zicam Cold Remedy.
In public statements discussing revenues and product safety, Matrixx did not disclose this
information. But the information was significant enough to likely affect a consumer’s decision to
7–7A. Disclosure under SEC Rule 10b-5
(Chapter 7—Page 120)
Even if Goldman did not affirmatively misrepresent any facts about the CDOs, Dodona can
recover if Goldman failed to disclose material facts. An omission is regarded as material if it is
(a) The court issued a summary judgment against the defendants and ordered
injunctive relief. The defendants were given time to respond to the injunction order, after which
“the court will determine . . . the appropriateness and amount of any order of disgorgement
with . . . interest as well as with respect to the assessment and amount of any other civil
penalties.”
The court found that Montana, Lyttle and Knight “misrepresented the use, safety and
control of the investor funds. Each represented to the investors that their funds would be placed
in a program that would generate extraordinary rates of return with no risk to the principal. The
evidence makes clear that neither promise was ever intended nor did it ever materialize. In fact,
8 UNIT ONE: BUSINESS ORGANIZATIONS
in whole or in part.
no Trading Program even existed.” The “Defendants' representations and assurances made in
of return and control of the funds they were investing, were important in terms of the investors'
decisions to invest.”
Proof of scienter is also required. “Persons who act with an intent to deceive or with
reckless regard for the truth are deemed to possess the necessary scienter.” In this case, “it is
clear that Montana . . . acted recklessly in relying on Lyttle's representations concerning the
It was also clear that Lyttle acted with scienter “insofar as he had to have known that his
statements about the Trading Program were false.” And Lyttle “continued to sign people up . . .
long after he well knew that the investor funds were being used in a manner contrary to his
representations to these investors and even after using some of the investors' funds for his own
personal purposes.”
substantive and official, which actually carried no legitimate significance with regard to the types
of trades supposedly to be conducted. In fact, . . . many of the representations in these
agreements have no significance in the financial world and amount to little more than gibberish.”
The court also referred to the investors as “unsophisticated.”
There is an adage that if something sounds too good to be true, it probably is. That would
Montana, Lyttle, and Knight’s representations as to the safety of the principal. The investors’
only ethical transgression may have been to trust too readily in their advisors’ veracity. In that
circumstance, it would seem less fair, or at least less supportable, that they should suffer a loss.
7–9A. LEGAL REASONING GROUP ACTIVITY—Violations of securities laws
in whole or in part.
in whole or in part.
CHAPTER 7: SECURITIES LAW AND CORPORATE GOVERNANCE 3
in whole or in part.
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 no motive to commit securities
fraud—they had nothing to gain by delaying the announcement of the First Flight’s
postponement. The court concluded that “a more plausible inference than that of fraud is that
the defendants, unsure whether they could fix the problem by the end of June, were reluctant to
tell the world ‘we have a problem and maybe it will cause us to delay the First Flight and maybe
not, but we're working on the problem and we hope we can fix it in time to prevent any
significant delay, but we can't be sure, so stay tuned.’ ”
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 company was helping their case.
But the plaintiffs did not identify their source. The lower court then refused to give any weight to
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.”
have been required to register with the SEC.
4 UNIT ONE: BUSINESS ORGANIZATIONS
© 2015 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website,
in whole or in part.
2A. Securities laws
Emerson did not fail to disclose a material fact in connection with the purchase or sale of
securities. What he did do was use bad judgment and breach a fiduciary duty by mentioning the
planned takeover to his uncle, who then took the information and used it to his advantage.
There is no indication in the facts that Emerson intended to do anything wrong or knew that his
uncle would use this information to trade on the information (that he should not have disclosed).
3A. Insider trading theory
required to certify the financial statements.
ANSWER TO DEBATE THIS QUESTION IN THE REVIEWING FEATURE
AT THE END OF THE CHAPTER
Laws against insider trading were put in place to prevent insiders—usually highly paid
upper-level managers—from undeservedly benefiting from their positions in the publicly head
companies. If insider trading were no longer illegal, insiders would stand to make fortunes from
buying the companies’ stock before good news is released. If the inside news is bad, insiders
can make fortunes selling short the companies’ stocks.
Specifically, the law imposes liability for making a false statement or omission that is
“material.” What sort of information would an investor consider material? The average
investor is not concerned with minor inaccuracies but with facts that if disclosed would tend to
deter him or her from buying the securities. This would include facts that have an important
CHAPTER 7: SECURITIES LAW AND CORPORATE GOVERNANCE 5
in whole or in part.
bearing on the condition of the issuer and its business—liabilities, loans to officers and directors,
2A. Lee is an officer of Magma Oil, Inc. Lee knows that a Magma geologist has just
discovered a new deposit of oil. Can Lee take advantage of this information to buy and
sell Magma stock? Why or why not? No. The Securities Exchange Act of 1934 extends
liability to officers and directors in their personal transactions for taking advantage of inside
(Chapter 7—Page 114)
Gustavo is right. Under Section 3(a)(11) of the Securities Act of 1933, stock offerings that are
restricted to residents of the state in which the issuing company is organized and doing
business are exempt from registration requirements. Therefore, the Estrada Hermanos offering
need not be registered with the SEC. The offering will, however, be subject to state securities
because no sale of stock is involved. The existing shares are merely being split, and no
consideration is received by the corporation for the additional shares created.
7–3A. Insider trading
(Chapter 7—Page 120)
can be established when it can be inferred that the most likely source of that belief was an
insider. For example, a stock purchase or sale’s proximity in time to a phone conversation
between a trader and one with inside information provides a reasonable basis for inferring an
exchange of that information. Thus, in this problem, on this basis, a court could hold David liable
for insider trading.
CHAPTER 7: SECURITIES LAW AND CORPORATE GOVERNANCE 7
in whole or in part.
that reasonable investors would have viewed this information as material. Zicam products
account for 70 percent of Matrixx’s sales. Matrixx received reports of consumers who suffered
anosmia after using Zicam Cold Remedy.
In public statements discussing revenues and product safety, Matrixx did not disclose this
information. But the information was significant enough to likely affect a consumer’s decision to
7–7A. Disclosure under SEC Rule 10b-5
(Chapter 7—Page 120)
Even if Goldman did not affirmatively misrepresent any facts about the CDOs, Dodona can
recover if Goldman failed to disclose material facts. An omission is regarded as material if it is
(a) The court issued a summary judgment against the defendants and ordered
injunctive relief. The defendants were given time to respond to the injunction order, after which
“the court will determine . . . the appropriateness and amount of any order of disgorgement
with . . . interest as well as with respect to the assessment and amount of any other civil
penalties.”
The court found that Montana, Lyttle and Knight “misrepresented the use, safety and
control of the investor funds. Each represented to the investors that their funds would be placed
in a program that would generate extraordinary rates of return with no risk to the principal. The
evidence makes clear that neither promise was ever intended nor did it ever materialize. In fact,
8 UNIT ONE: BUSINESS ORGANIZATIONS
in whole or in part.
no Trading Program even existed.” The “Defendants' representations and assurances made in
of return and control of the funds they were investing, were important in terms of the investors'
decisions to invest.”
Proof of scienter is also required. “Persons who act with an intent to deceive or with
reckless regard for the truth are deemed to possess the necessary scienter.” In this case, “it is
clear that Montana . . . acted recklessly in relying on Lyttle's representations concerning the
It was also clear that Lyttle acted with scienter “insofar as he had to have known that his
statements about the Trading Program were false.” And Lyttle “continued to sign people up . . .
long after he well knew that the investor funds were being used in a manner contrary to his
representations to these investors and even after using some of the investors' funds for his own
personal purposes.”
substantive and official, which actually carried no legitimate significance with regard to the types
of trades supposedly to be conducted. In fact, . . . many of the representations in these
agreements have no significance in the financial world and amount to little more than gibberish.”
The court also referred to the investors as “unsophisticated.”
There is an adage that if something sounds too good to be true, it probably is. That would
Montana, Lyttle, and Knight’s representations as to the safety of the principal. The investors’
only ethical transgression may have been to trust too readily in their advisors’ veracity. In that
circumstance, it would seem less fair, or at least less supportable, that they should suffer a loss.
7–9A. LEGAL REASONING GROUP ACTIVITY—Violations of securities laws
in whole or in part.
