B-1
ALTERNATE CASE PROBLEM ANSWERS
CHAPTER 42
INVESTOR PROTECTION, INSIDER TRADING,
AND CORPORATE GOVERNANCE
42-1A. Violations of the 1934 Act
The court refused to dismiss the complaint. The court explained, “A statement is material if its
disclosure would alter the total mix of facts available to an investor and if there is a substantial
likelihood that a reasonable shareholder would consider it important to the investment decision.
42-2A. Insider reporting and trading
The court ordered Bleakney to disgorge his profits. The court explained that Section 16(b) of the
Securities Exchange Act of 1934 precludes corporate insiders from making short-swing profits
from transactions in the corporation’s stock. “The statute requires disgorgement to the company
B-2 APPENDIX B: ALTERNATE CASE PROBLEM ANSWERS—CHAPTER 42
42–3A. Insider trading
The most likely allegation in these circumstances was that Scott violated Section 10(b) and SEC
Rule 10b-5 by communicating material nonpublic information to Mark and Jordan, who then
bought EZ stock based on that information. To establish liability under Section 10(b) and SEC
42-4A. Definition of a security
The federal district court in which this case was brought held that the investment contracts were
securities within the meaning of the Securities Act of 1933—a “contract, transaction or scheme
whereby a person invests his money (1) in a common enterprise and (2) is led to expect profits
42-5A. Section 10(b)
The district court dismissed the complaint, and the plaintiffs appealed. The U.S. Court of Ap-
peals for the Second Circuit affirmed. Both courts reasoned that GE’s motive was not enough to
42-6A. SEC Rule 10b-5
The court held that Falbo was liable under the misappropriation theory. Grand Met placed Falbo
in a position of trust and confidence, which, like the restrictions of a fiduciary relationship, pro-
hibited him from taking advantage of the position for his personal gain. Despite this responsibil-
42-7A. Definition of a security
The court held that the franchises were investments required to be registered under the Securi-
ties Act of 1933. The court ordered the Levines to stop selling the franchises, refund the inves-
tors’ money, and pay damages at the “highest allowable level.” The court pointed out that a se-
B-4 APPENDIX B: ALTERNATE CASE PROBLEM ANSWERS—CHAPTER 42
achieve and maintain a five percent (5%) market share of electric power residential customers in
42–8A. Violations of the 1934 act
Five elements are required to establish a violation of Rule 10b-5. A plaintiff must show (1) a ma-
U.S. Court of Appeals for the Ninth Circuit affirmed.
42–9A . Insider trading
No. These allegations are not sufficient to show a violation of Rule10b-5 for insider trading
claims because the complaint was too general. The allegations were insufficient to state Section
10(b) and Rule 10b-5 insider trading claims against corporate insiders, who had traded in stock
42-10A. A QUESTION OF ETHICS
1. One cannot escape the suspicion that Willis realized that his use of the inside in–
formation was, at a minimum, unethical. More than perhaps any other members of the medical
APPENDIX B: ALTERNATE CASE PROBLEM ANSWERS—CHAPTER 42 B-5
profession, psychiatrists, due to the nature of their profession, have a duty to hold information
2. It would seem unlikely that Willis’s individual investment, in itself, would be harmful to
Weill’s interests. It is conceivable, however, that even by telling just one other person—the
3. One could simply argue that it would be basically unfair to allow other persons—