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1
CHAPTER 42
INVESTOR PROTECTION, INSIDER TRADING,
AND CORPORATE GOVERNANCE
ANSWERS TO CRITICAL THINKING QUESTIONS
IN THE FEATURE
MANAGERIAL STRATEGY—BUSINESS QUESTIONS
1. Why might the new SEC pay-ratio disclosure rule cause certain businesses to
eliminate low-wage workers? The new Securities and Exchange Commission pay-ratio
2. How might the new SEC pay-ratio disclosure rule help shareholders? One of the goals
of the Dodd-Frank Wall Street Reform and Consumer Protection Act was to improve
ANSWERS TO QUESTIONS
AT THE ENDS OF THE CASES
CASE 42.1—CRITICAL THINKING
LEGAL ENVIRONMENT
Would a reasonable investor have cause to complain if an issuer, without having
consulted a lawyer, states, “We believe our conduct is lawful”? Explain. Yes, a reasonable
2 UNIT EIGHT: BUSINESS ORGANIZATIONS
CASE 42.2—CRITICAL THINKING
WHAT IF THE FACTS WERE DIFFERENT?
Suppose that further drilling had revealed that there was not enough ore at this site to be
mined commercially. Would the defendants still have been liable for violating SEC Rule
10b-5? Why or why not? Assuming all of the other circumstances are as they are stated in the
CASE 42.3—LEGAL REASONING QUESTIONS
1. Scienter can be established by showing a defendant’s motive to commit fraud. In the
context of the Rand-Heart case, what act might have established motive on Dolan’s part?
In any case in which a shareholder alleges a violation of Section 10(b) or Rule 10b–5 by a
corporation’s director or officer, motive to commit fraud could be established on a showing that
2. When Bank of America met with Dolan to discuss his company’s financial situation, it
demanded that the company be restructured. Dolan did not disclose this fact in the Form
10–Q or in his conference with stock analysts. Was this omission misleading? No, the
omission of the fact of Bank of America’s demand that Dolan Company be restructured was not
3. Suppose that Dolan had disclosed Bank of America’s action with respect to
DiscoverReady in the Form 10–Q and the conference. Would the result have been
4 UNIT EIGHT: BUSINESS ORGANIZATIONS
ANSWERS TO QUESTIONS IN THE REVIEWING FEATURE
AT THE END OF THE CHAPTER
1A. Registration
In this scenario, Dakota Gasworks was the target company in a successful takeover; it did not
2A. Securities laws
Emerson did not fail to disclose a material fact in connection with the purchase or sale of
3A. Insider trading theory
Because Wallace acquired inside information as a result of Emerson’s breach of his fiduciary
4A. Certification
ANSWER TO DEBATE THIS QUESTION IN THE REVIEWING FEATURE
AT THE END OF THE CHAPTER
Inside trading should be legalized. The more quickly information about publicly held
companies gets into the hands of the public, the more efficient the stock market
CHAPTER 42: INVESTOR PROTECTION, INSIDER TRADING, & CORPORATE GOVERNANCE 5
ANSWERS TO ISSUE SPOTTERS
AT THE END OF THE CHAPTER
1A. When a corporation wishes to issue certain securities, it must provide sufficient
information for an unsophisticated investor to evaluate the financial risk involved.
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
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
ANSWERS TO BUSINESS SCENARIOS
AT THE END OF THE CHAPTER
42-1A. Registration requirements
Gustavo is right. Under Section 3(a)(11) of the Securities Act of 1933, stock offerings that are
42-2A. Registration requirements
42–3A. Insider trading
There is likely enough evidence in the facts of this problem to find that David violated the law
because there was a clear pattern—every time David called his brother or father, Mark or
6 UNIT EIGHT: BUSINESS ORGANIZATIONS
ANSWERS TO BUSINESS CASE PROBLEMS
AT THE END OF THE CHAPTER
42–4A. BUSINESS CASE PROBLEM WITH SAMPLE ANSWER—Violations of the 1934 act
An omission or misrepresentation of a material fact in connection with the purchase or sale of a
security may violate Section 10(b) of the Securities Exchange Act of 1934 and SEC Rule 10b-5.
The key question is whether the omitted or misrepresented information is material. A fact, by
42–5A. Disclosure under SEC Rule 10b-5
Even if Goldman did not affirmatively misrepresent any facts about the CDOs, Dodona can
42–6A . Violations of the 1933 act
Yes, World Trade violated the Securities Act of 1933. It is a violation of this act to sell securities
without registration unless they qualify for an exemption. It is also a violation of the act to sell
42–7A . Securities Act of 1933
Yes, liability under the Securities Act of 1933 can be imposed on a seller for a false statement
that was made by someone else. It is a violation of the Securities Act to intentionally defraud
42–8A. The Securities Exchange Act of 1934
The scheme perpetrated by the Reyes-Rivera brothers—a fraudulent investment operation that
paid returns to investors from new capital paid to the fraudsters rather than from a legitimate
investment—is known as a Ponzi scheme.
42-9A. A QUESTION OF ETHICS—Violations of the 1934 act
(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
CHAPTER 42: INVESTOR PROTECTION, INSIDER TRADING, & CORPORATE GOVERNANCE 9
(b) The court described the documents that Montana, Lyttle, and Knight supplied to
the investors as including “many sections which contained provisions clearly designed to appear
substantive and official, which actually carried no legitimate significance with regard to the types
10 UNIT EIGHT: BUSINESS ORGANIZATIONS
ANSWERS TO LEGAL REASONING GROUP ACTIVITY QUESTIONS
AT THE END OF THE CHAPTER
42–10A. Violations of securities laws
(a) Svoboda and Robles committed fraud when they traded securities using the
nonpublic information that Svoboda had access to. Criminal charges could be filed against them
under Section 10(b) of the Securities Exchange Act of 1934 and Securities and Exchange
(b) Svoboda and Robles are also subject to civil liability for their actions. The SEC
(c) Svoboda’s might defend against the civil charges by arguing that he had been
