Business Law Chapter 42 Homework Suppose that further drilling had revealed that

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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