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82 Cards in this Set
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- Back
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Sarbane-oxley
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sarbanes-oxley…passed recently due to the corruption of some companies…enron. Congress got involved due to the corruption fraud.
The 1933 and 1943 was response to the crash of the stock market. Sarbane-oxley…main function is the audit. the audit committee didn’t do a good job. Congress steps in and creates an audit outline for the committee (standards). External audit comes in and look at the financial statements and they will certify it. Companies also have internal audit to make sure that everything is the same. The external reports to the committee audit and not to the chief of the board because some chief of the board is the CEO of the company. SO also required that someone on the audit committee to know something about accounting. Need to have experts in that area. Also, change the members of the committee audit board periodically because over time ppl will state to overlook mistakes. Sarbane-oxley…holds the company accountable. Have to have documents for at least 7 years. It required that all financial statements are certified by CFO and CEO… by signing the documents. They have to make sure that the financial statements were prepared correctly or it’s on their head. Required in-house attorney to report any fraud they think/may detect to the board because they are the person to detect it first. It’s expense when compliance. fines up to $5 Million and up to 20 years in prison or both |
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Securities Act of 1933 (Registration)
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33 act deals with security registration…if you want to sell stock to start a business and raise equity, you’ll have to register the stock issues or must be an exempt transaction or security. If you don’t register or it is not an exempt transaction then it’s a felony.
What is a security…it includes stocks and bonds, promise notes, investment in an orchard (book talked about this). If you are dealing with security and does not follow the security law.. it’s a felony. Don’t want to guess wrong if something is a security or not. Sometimes a contract can be a security….limited partnership interest also. Requirements…investment in a common enterprise where other ppl are investing in the same invest as you at the same time…common investment… you expect to make a profit. And those profits are derived from the efforts of someone else… you are passive. Someone else is going to do the work, you are the owner. It’s a bit broad. When in doubt and you’re trying to raise money for business… get a legal opinion…don’t want to be wrong. 33 acts deals with registration on security issues. You want to raise equity…by selling stock. Do so by registering with SEC and must be approved or exemption transaction. Limited partnership…is also a security, it is important because now you’re dealing with both the federal and state laws (security laws). It’s important to know what you are doing. BN regulates the initial offering of securities by public corporations by prohibiting an offer or sale of securities not registered with the SEC. |
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Securities Exchange Act of 1934 (Trading)
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BN
regulates the trading in securities once they are issued. It requires brokers and dealers who trade in securities to register with the SEC. |
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Securities Investor Protection Act of 1970
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established the non-profit Securities Investor Protection Corporation and gave it authority to supervise the liquidation of brokerage firms that are in financial troubles, as well as to protect investors from losses up to $500,000 due to the financial failure of a brokerage firm. SIPC doesn’t have the monitoring and bailout functions of FDIC; it only supervises the liquidation of an already financially troubled brokerage firm through an appointed trustee.
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Foreign Corrupt Practices Act of 1977
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in security laws….it’s a felony to bribe a foreign official or any official
bn prohibits the direct or indirect giving of “anything of value” to a foreign official for the purpose of influencing that official’s actions. FCPA also requires all companies to set up a system of internal controls that will provide reasonable assurance that the company’s records accurately and fairly reflect its transactions. |
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Private Securities Litigation Reform Act of 1995
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involves private civil suits not criminal suit. Focus of the act is on security fraud class action. It came to a point where companies where paying extortion when they where sued. It was cheaper for companies to pay than to go to court….that’s not right. The act made the pleading stands in the security fraud more difficult. If you want to file a security fraud class action against a company you have to plead specific allegations of fact. Ex. to win, the ppl misrepresenting knew that they were misrepresenting. A knowledge is required. It’s hard to prove. If you want the complaint to withstand the motion to dismiss, you have to plead specific factual allegations that the defends know that what they’re doing is not true. What happen is that so many security frauds get dismissed at the pleading state that it prevents distortion.
bn provides a safe harbor from liability for companies that make statements to the public and investors about risk factors that may occur in the future. |
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Penney Reform Act of 1991
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increase the penalty…for fraud and other things including trouble damages for insider trading
bn gives the SEC cease-and-desist powers and the power to impose substantial monetary penalties up to $650,000 in administrative proceedings. This Act also gives the SEC and federal courts the power to bar anyone who has violated the fraud provisions of the federal securities laws from ever serving as an officer or director of a publicly held firm. |
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Securities and Exchange Commission (SEC)
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Administrative agency… they are very powerful, non elected officers. 5 commissioners, current officer in chief is Mary Schapiro. 5 year terms, only 3 from a particular political party. They review filing from corporations, review registration statements, epoxy for voting… powerful agency.
Created under the 1934 Act For purpose of full and fair disclosure with respect to material facts in registration and trading 5 commissioners, 5 year terms, only 3 from a particular political party Divisions (Corporate Finance, Market Regulation, Enforcement, Corporate Regulation and Investment Management) bn different divisions Corporate Finance: responsible for establishing and overseeing adherence to standards of financial reporting and disclosure as well as for setting and administering the disclosure requirements. It also reviews all registration statements, prospectuses, and quarterly and annual reports of corporations as well as their proxy statements. Market Regulation: regulates national security exchanges as well as broker-dealers registered. It seeks to discourage manipulation or fraud in the issuance, sale, or purchase of securities. Enforcement: responsible for the review and supervision of all enforcement activities, investigations, and the initiation of injunctive actions. Corporate Regulation: administers the Public Utility Holding Company Act of 1935 and advises federal bankruptcy courts in proceedings. Investment Management: administers the ICA of 1940 and the Investment Advisers Act of 1940. All investigations arising under these acts dealing with issuers and dealers are carried out by this division. |
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who's the current Chief of SEC?
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Mary Schapiro
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Limited partnership
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is also a security, it is important because now you’re dealing with both the federal and state laws (security laws). It’s important to know what you are doing.
bn limited partnership can be a security |
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SEC v. Howey
*note: this case was not mention in lecture, but is on lecture slide |
Howey Co. owned large tract of citrus groves in Florida. It kept half of it for its own use and sold real estate contracts for the other half. Howey marketed through a resort hotel it owned in the area, promising significant profit to those that invested. Most of the purchasers were not from Florida and knew little about agriculture. Howey didn’t file any registration statement with the SEC and the SEC filed suit to obtain an injunction forbidding the defendants from using the mails and instrumentalities of interstate commerce in the offer and sale of unregistered and nonexempt securities but got denied.
The court held that the sale of rows of orange trees to the public with a service contract, under which the Howey Company cultivated, harvested, and marketed the oranges, constituted a security within the meaning of Section 2(1) of the 1933 Act. Its decision was based on three elements: 1)There existed a contract whereby an individual invested money in a common enterprise, 2)the investors had reasonable expectations of profits, 3)the profits were derived solely from the efforts of persons other than the investors |
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Securities Act of 1933:
Registration Statement (S-1) |
Registrations… you must provide info for the purchasers so that they can make a judgment on the business and the risk…you must disclose to potential purchasers.
the registration…two parts 1. prospectus…given to anyone that request it who is interest in purchasing the stock. 2. information statement…. A lot more details, they go to the SEC. More details on financial statements. Must be filed with SEC before any securities can be sold to the public bn Prospectus: -given to anyone who requests that is interested in the stock (has financial information also) -Contains material information about the business and its management, the offering itself, the use to be made of the funds obtained, and certain financial statements. Information Statement: additional financial information (more detailed); not given to prospective buyers but is open for public inspection at the SEC |
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Securities Act of 1933; Registration Statement (S-1):
prospectus |
given to anyone that request it who is interest in purchasing the stock.
It’s info. That buyers want to know. 1. Material info about the company… what they do, are they foreign? Domestic, how do they make money, 2. purpose…the purpose of selling stocks, what are they going to do with the money. Ex. if they are just going to cash out the money…would that benefit the buyer? No…it comes in and then out. However, if they say that they are raising money to expand the company…than that’s a good thing…cause they contribute to earning per share. 3. What are the risk of the company. Need to be honest and disclose them. If you understate them then it could be fraud. What are the risks? Ex. jetblue…started at a carrier that fly at night. Could be oil prices (affect earning…cost structures). They could pass it onto the passenger. Might run into future contract. Also, oil strike, terrorist. 4. Managerial experience… cause investors are passive, they want to know who is running the company…who is around and what there experience is. Ex. jetblue, you would want someone that is experience in the airline. Want someone that understands the problem and have been through it. They know much about the business…not just finance….want to see ppl who knows about airline problems as wellas financing. 5.Certified Financial statements…it’s expensive and time consuming. bn: -given to anyone who requests that is interested in the stock (has financial information also) -Contains material information about the business and its management, the offering itself, the use to be |
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Securities Act of 1933; Registration Statement (S-1):
information statement |
A lot more details, they go to the SEC. More details on financial statements
bn additional financial information (more detailed); not given to prospective buyers but is open for public inspection at the SEC |
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Securities Act of 1933:
Stages of Registration Process |
Stages of Registration Process
1. Pre-filing (no offers to sell or buy) 2. Waiting period (between filing and effectiveness of registration statement) “Red Herring” 3. Post-effective period (Section 8 stop order) “Shelf Registration” “Underwriters” – Investment banking firm that agrees to purchase a securities issue from issuer usually on a fixed date for a fixed price with a view to selling the issue to the public. |
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Securities Act of 1933; Stages of Registration Process:
pre-filing |
when you have decide to go IPO. It’s before you file for registration. When file to SEC and approved, you’ll be able to sell. If not, you cannot sell because at that pt. Ppl don’t have info. Form s-1.
bn Happens before you file registration statement with sec |
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Securities Act of 1933; Stages of Registration Process:
Waiting period |
SEC will go over the files in 20 days…if they have questions, they will send it back…therefore, it’s more than 20 days until SEC are stratified. Within the waiting period you can generate some interest so when you go public…ppl will buy, therefore, you can distributed a form of the S-1 but not the finial S form called the Red Herring. That has all the files and info filed to the SEC…so that you can generate some interest…so when it goes public…you can sell it out as quickly as possible. Called red herring because of the red ink that said it’s not the final version of the form. Once SEC approve, it becomes effective.
bn Oral offers may be made but no sales. “Red Herring”: prospectus that summarizes the registration but disavows in red print any attempt to offer or sell securities |
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Securities Act of 1933; Stages of Registration Process:
Post-effective |
you can now sell stocks.
bn Offer and sale are now permitted. The registration statement becomes effective 20 days after it is filed. |
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Securities Act of 1933; Stages of Registration Process:
Shelf registration |
because registration is expensive, you don’t want to sell out little shares with in a short period of time. Therefore, you want to register a lot of shares at once. Shelf registration is where you keep some shares and sell the rest so that the market can absorb the first shares… by doing this, the price of the stock doesn’t go down. Ex. you register for 5million shares. You only want to sell 2 mil and then after a few years…you sell the rest…. At this time, the demand for it is high and you’ll gain more money. Also…you wouldn’t want to sell it say after 9/11
bn Procedure whereby large corporations can file a registration statement for securities it wishes to sell over a period of time rather than immediately |
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Underwriters
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Underwriters – some companies are not specialized in selling stocks. Therefore, the underwriters buy the stocks and sell it to the public. Investment banks are those that buys and sell. They can make a lot of money. If they fully underwrite an issue…stating that they will get a certain amount of money for every share, they are guaranteeing. It’s risky for them because the market might be different…say, what if the share drops? However, they would earn money if the shares goes up.
Underwriters and company… the company want to max. and the underwriters want to buy the cheapest.. therefore, underwriters sometimes are paid by commission if the company thinks that their share will go up. |
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Spinning:
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getting stock on the ground floor (when the stock is first opened – usually sold to those the company wants to associate with) Google – everyone wants to buy a share i.e. the stock price curve rises later but it is sold in the beginning
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Laddering:
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giving an allocation of shares at the offering price subject to an agreement that they buy additional shares throughout the day
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Securities Act of 1933:
exemptions |
1. Private Placements (Section 4(2) and Rule 146)
2. Intrastate Offering (Section 3 and Rule 147) 3. Small Business Exemption (Regulations A and D) 4. Rule 144 (based on Section 4(2)) |
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Securities Act of 1933; exemptions:
Private placements |
selling out shares to institutional investors (II). It’s exemption because II doesn’t need any help, they can get any info. They need. Benefits??? Doesn’t have to go through registration. They can sell it to Metlife (insurance company), teacher fund, Calprvs, Hartford. They are sophicated group. What you would do is…before going public, you call them up and ask if they want to buy…and telling them the yield. Can do it through the telephone…when doing private offering.
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Securities Act of 1933; exemptions:
Intrastate offering |
federal laws are all interstate. You can avoid federal law (registration) by selling to, say, the state of cal. However, 80% of your assets and gross incomes are form cali. 80% of your proceeds from the offering are to cali. The problem is that you must sell to the residents of that state. However, many ppl have multiple homes and is resident of..say.. AZ…therefore, you don’t want to be wrong. you have to be resident of cali or there’ll be consequences. Therefore, you want a prove of resident to cover your ass.
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Securities Act of 1933; exemptions:
Small business exemption |
this is because registration is expensive. Ex. if they get register and it’ll cost them 1 mil…this doesn’t make sense. Therefore, they do not need a lot of details for the registration statement. Can substitute with something called offering circular…not as much details and easier…and most importantly… does not need an audit of the finance statements (this will save a lot of money). There is a limited of $5mil for each issue…reg A???????. Also have reg D…also have 5mil ceiling…but doesn’t have to go through the offering circular… but they can only sell to credited investors….however, they are not protected by the registration statement.
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Securities Act of 1933; exemptions:
rule 144 |
Ppl who buys the exempt stocks can not sell it…there’s a holding period or else it’ll be like underwriting. The holding period for intrastate is 9 months and everything else is 1 years. The problems is that in the time of the holding period…you want to sell stock because the market is going to go down... But cant.
some ppl will try to get over the system… so they’ll do a lot of offering…. Of 5 mil. For three offerings. If the money from those three offerings are use for the same purpose…SEC will view the three offerings are one (called integration) 15 mil and there will no longer be an exemption. |
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Securities Act of 1933:
Liabilities |
1. Material Misprepresentation in Registration Statement (Rule 405 – “material”)
***Who can be held liable? (Section 11) [reliance and scienter not required] Defenses: Purchaser knew of untruth of omission, decline resulted from causes other than the statement, statement prepared with the expected due diligence. 2. Failure to file a Registration Statement (12(1)) 3. Misrepresentation or fraud in the sale of a security. (12(2)) – only recovery from person who sold [whether or not a registration statement] 4. Fraud in the sale of a security (17(a)) – criminal penalties (aiding and abetting – Control person) |
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Securities Act of 1933; Liabilities:
Material misrepresentation |
Material misrepresentation… a buyer reads the material, likes it, and buys the stock, but later finds out that the info. that they used in the material was a determining fact for them to buy the stock was misleading or was not true to what it said… there’s a material misrepresentation. They now have a cost of action under section 11. it must be a material misrepresentation and significant…cant be missing of a comma. Must be something like understating a risk fact….this is not fraud. Fraud is when someone knew what they are say is false. It’s more like negligence. And you would sue for your damages. Ex. a drug company that you bought and there’s material misrepresentation… you can sue the officers, attorney, the issuer of the stock, directors, sue the firms doing the auditing…can sue them all. The problem is that any of the party beside the issuer, they can claim due diligence of defense where they were not aware of the issue. They can say that they did there part and was not aware of the other parts.
bn Section 11 allows a right of action to “any person acquiring such a security” who can show: a) a material misstatement or omission in a registration statement and b) monetary damages “material”: pertaining to matters “of which an average prudent investor ought reasonably to be informed before purchasing the security registered.” -Who is liable? Every person who signed the registration statement; all directors, accountants, appraisers, engineers, and other experts who consented to preparing registration statement; every underwriter -exceptions: 1. an expert is liable only for the misstatements in the portion of the registration statement he/she prepared 2. an underwriter is liable only for the aggregate public offering portion of securities |
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Securities Act of 1933; Liabilities:
Prosecuted for not filing a registration statement. |
When would you not file one…you thought u have an exemption but u didn’t. or you’re dealing with a contract and falls under the security law but u didn’t know. Penalty is rescission? Ex. stock is $20 and wasn’t exempt…you have the right to rescission…if the stock is selling for $2, the company will now have to give you $20. you give the stock back for your money. Who eats the differences? The company. That’s $18 lost per share.
bn Section 12(1) provides that any person who sells a security in violation of Section 5 is liable to the purchaser to refund the full purchase price |
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Securities Act of 1933; Liabilities:
Fraud in sale of a security or Misrepresentation |
fraud is intentional to deceived that creates financial lost. A person tells you they have made a contract with the navy and walmart about a product that helps sailors deal with sea sickness so you buys the stock, but later, it turns out that the guy never got a deal with the navy nor walmart. That’s fraud, you can sue.
bn Section 12(2) is applicable whether or not the security is subject to the registration provisions of the 1933 Act, provided there is use of the mails or other facilities in interstate commerce |
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Securities Act of 1933; Liabilities:
aiding and abetting |
Aiding and abetting a fraud is fraud, but it is secondary. The primary party
commits the fraud and the aider or abetter helps them from the background. The difficulty is that in securities law the courts have not regarded aiding and abetting as an actionable civil tort --Stoneridge and Central Bank. However, aiding and abetting is a criminal offense. So, in securities law an aider and abetter can be held criminally liable but not civilly. Any fraud, civil or criminal, requires that the plaintiff/prosecution establish an intent to deceive. In other words they must know what they are doing is fraud. This is also referred to as scienter. bn Imposes criminal, and possibly civil, liability on anyone who aids and abets any fraud in connection with the offer or sale of a security |
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Control person liability
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Section 15 of the Securities Act – anyone in control of a person liable under Sections 11 or 12 is jointly and severally liable unless control person had no knowledge or reasonable ground to believe the existence of the facts on which liability is predicated
Section 20(a) of the Exchange Act – same liability unless the person acted in good faith and did not directly or indirectly induce such action. *** is it necessary to prove Culpable participation? Control person liability– taken off of internet “Control person liability does not lie unless the controlling person was, in some meaningful sense, a culpable participant in the fraud. General deficiencies in supervision, are insufficient, liability requires culpability regarding specific trades and misrepresentations. Control person liability will not lie unless the “controlling person was in some meaningful sense a culpable participant in the fraud.” lecture notes base on the buck stop…where there’s a fraud in the accounting department so then the CFO would be reliable for that department…does the buck stop at the CFO??? Since the CFO works for the CEO?? there at two separate section that pretain to control and liability. One is in the 33 act related to registration and the other one is in the 34. If you want to go after a control person…they must be in control. They must have control over the whole affair or control of the transaction. A CEO can be a control person. Section 15, the control person have knowledge of the fraud or facts to believe that there is fraud. Indirect or direction. If there are red flags. Red flags is contributed to culpable participation. Ex. preregrine case…a lot of fraud. The prosecutor tries to get gore? And other ppl as control person. He said that he didn’t know about it since it wasn’t on his floor. He got off. slide note Control” control over general affairs of the entity and power to directly or indirectly control the corporate policy that resulted in the violation. OR “Control” exercise of control over operations in general and possessed power to control the specific transaction on which the violation is predicated. |
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Bernie Ebbers at Worldcom case
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deals with Control Person Liability
massive fraud… said, cant get him for control person because he didn’t know about it. He didn’t know anything about finance…just general knowledge. He also said he doesn’t know anything about accounting. He is the CEO of the company. However, the prosecutor said that he is very predetail on things cause when the free coffee was costing money, he took it away and made the employees play for it. The juries didn’t buy his statement. Also, they asked if he talked to soliven And he said no….however, his office and soliven Is right next to each other…. So if that was a lie and whatever he said was a lie…25 years in prison. |
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CEO of Enron case
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Deals with Control Person Liability
jeff skilling… SEC tries to nail him for fraud…so they got the offer meetings transaction roaster of Enron and he was on it. When asked, he said he had to go to the bathroom and missed it. He is now doing 20 years. |
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Registration of Broker/Dealers
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“Broker” – in the business of effectuating transactions in securities for the account of others.
“Dealer” – engaged in business of buying and selling securities for their own account.. Broker/Dealers must be registered under the 1934 Act unless exempted. Section 15(b) – licenses may be revoked under anti-fraud provisions or censure if offense not as severe. Broker and dealer….he’s not going to cover much details going to the stock exchange. SRO…. Self regulating organization… if you have stock and traded on stock exchange. You much follow SEC rules and the rules of the stock exchange your stock are traded in. regulation FD (fair disclosure), passed by SEC, there was a problem before FD… the company would invite in the analysis and disclose whatever it is in the morning, then in noon, the company disclose it to the public. So with a 2 hrs. gap there’s an advantage….he analysis can buy/sell the stock before the info. Are disclosed to the public. Therefore, the FD is where you have to release the disclose info at the same time to both the analysis and the public. |
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12G company
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Anyone that’s a 12G company …section 12 of the 34 act… can do several things. Two groups: company register stocks or bonds. Or, company that are privately owned. And had not gone through register. But they have 500 shareholders and 10mil in assets. These 12G companies will need to meet some requirements….they need to send SEC the proxy that one intend to use so that they can review it. There’s also reporting requirements…must file an annual report…it’s a 10K. Have to file a quarterly report on a 10Q form. If something happens within the quarter, you’ll have to file a AK. If you file a forms and there’s fraud…shareholder can sue. Annual reports…lots of financial info…must be audit by the external. Quarterly reports doesn’t need to be audit…but also have lots of financial info. MDA….management, discussion, and analysis… where management will describe what they are doing and plans to do. Where they are and where they are going.
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Proxy Solicitation
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Usually, the voters doesn’t show up…so you vote by proxy…where you give someone else your vote to vote for you. Proxy for management… u either vote for them or not…where you would withhold the vote. If the company doesn’t have a majority voting…then the director only needs one vote to win. There’s also staggering where each year only 1/3 are elected. It makes it hard for another company to takeover.
Section 14 (Williams Act) of the 1934 Act and accompanying regulations lay the groundwork for proxy solicitation. Very few shareholders attend annual meetings and proxy solicitation is the mechanism for non-attending shareholders to vote. All companies registered under the Securities Act must file proxy statements with the SEC 10 days before mailing to shareholders. (may require changes) Rule 22 – several items of information must be included in all proxies such as revocability, and notice of interest that soliciting party has in the subject matter. |
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Shareholder Proposals
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In the proxy…there’s a method where shareholder can include a shareholder resolution to be voted by other shareholders. You would summed to managements for exclusion in management proxy. The topics that you can request are very narrow…you cannot put in a resolution for a personal grievance or something requesting managerial (telling managements what to do). Therefore, there’s not much left… can put in stuff like we shouldn’t do business with this company, country.
Marry something…head of sec note on slide Rule 14(a)(8) – requires management to include shareholder proposals in proxy statements (200 words or less) if notified in a timely fashion. Management can then give its opinion of the proposal in the proxy. Management may exclude certain proposals if proposal is unlawful, proposal is a personal grievance, it is related to ordinary operational functions (p. 528) |
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Proxy Contests
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Both Management and Insurgents can submit proxies for election of a slate of directors.
Insurgent group must file disclosure statement with the SEC (criminal records etc.) Insurgents entitled to shareholder lists Mailing and proxy preparation costs can be prohibitive – deck is stacked in favor of management. |
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Insurgent group
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waging the proxy fight. They need to tell the SEC who they are… so ppl know who they represents. Who’s behind it. If you’re going to wage a proxy contest.
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Tender Offers/Takeover Bids
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Catberry… was approached by craf… about a possible merging… it was done informally…catberry dosn’t want to go with it. If you’re a craf…u can do it friendly in a merger agreement with management or buy stocks and have 51% of the company…therefore, you own it.. can be expensive. If you have 5% of the company stock…u’ll have to go public… file a 12G…it identify who you are. Once the market is aware that a big company is planning to take over… the share price will go up because ppl anticipate that there will be a demand for stock. A third possibility is a tender offer. Where you make an offer to the shareholders and target by giving them a certain amount of money to the shareholders for their stocks. Tending their shares… a premium prices are given….ex. 100% more than the market price. Tenders offer have conditions… offers are only affective if at least a certain amount of the shares they want are tenders… they want enough tender shares that will get them 51% of the company. If for whatever reason, shareholders doesn’t want to tender their shares, then they can take the offer of withdraw.
Once the tender offer is made, it goes public…”we offer to buy x dollars within an opening date and if you’re tending the share… we’ll pay x dollars. Once that’s public…the price will go to…but wont reach $50. if the tender fail…then the price will go back down... The shares at this point is called in-play If you are the management of the target…how would you feel about a take over? Usually… there's a takeover because the company was poorly ran and that the takeover company feels that they can fix the problem and make great profits out of the company. Therefore, the first thing that would probably happen is getting rid of the management and board. Due to a tender offer, must file to SEC…who are they, what they represents. The target management needs to identify what they are going to do with their personal shares…are they going to tender it. Or fight it and hold their shares… for a long term value of the targeted company…the management would say that it is best to keep the old management because they understand the company. What usually happens is that the management will response with an add saying stuff like… why the taking over company should keep them as the management once the company is taking over… they’re saying…why the shareholder should stick with them and not take the tender offer even if the other company offers a premium. If the shareholders doesn’t tender, then it goes away and the managements win the fight. There’s great pressure from both sides to convinced the shareholder to take their side. Therefore, there’s the 14e which prohibit ppl from making untrue statements or commit fraud in connection with a tender offer. Acquiring party, using public tender offer, seeks to purchase controlling interest in the target. (Offer will usually appear in a paper of national circulation such as the WSJ or NYT) Rules – Section 13 and 14 of 1934 Act Any person or group the acquires more than 5% of any class of stock must file a statement with the target and the SEC which must disclose background of group, source of funds, purpose of acquisition, relevant contracts, plans if any for target company. [on the radar] |
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14e
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prohibit ppl from making untrue statements or commit fraud in connection with a tender offer.
Criminal offense to make an untrue statement or commit fraud in connection with a tender offer. (civil remedies also available) |
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Tender Offers/Takeover Bids:
defensive strategies |
In the event of a takeover…there are defensive strategies management can do to prevent a takeover…there are limits. If you’re the shareholder or target… you might want to tender your share and it would be hard to tender your shares if management puts up a lot of defensives. Therefore, it’s okay to put of defensive strategies, provided that they see the take over company as a treat to corporate policy and that the defensive strategies is proportional to the risk. First, before they have defensive strategies…they must identify what they see is risks when another company takes over. After this…they can deploy a defensive strategies that are proportional to the risk.
1. Golden parachute 2. Poison Pill (new class of stock) 3. Buy out of hostile (“Greenmail”) or (“Standstill”) 4. Issue treasury shares (to friendly party) 5. Move to state with “shark repellant” statutes 6. Find a “white knight” 7. Supermajority (“Porcupine” provisions) in by-laws 8. Bankruptcy (“Scorched earth”) 9. Pac-Man (Reverse Tender offer) 10. Sell a Crown Jewel 11.Filing delaying lawsuits 12.Create an ESOP |
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Tender Offers/Takeover Bids;
defensive strategies: Golden parachute |
where management of the target…through the vote of boards of directors… that in the case of a take over, they are paid a large sum of severance package when they leave the company…so if the company is taken over…and they are fired…they’ll have a save parachute when they land. And the takeover company have to honor it…it’s part or the contract. If the amount is very high… it discourages the takeover company.
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Tender Offers/Takeover Bids;
defensive strategies: Poison pill |
before the takeover happens…the board of directors issue rights to the existing shareholders… it maybe say that in the event where a trigger event occurred… where a takeover acquires a certain amount of shares, the existing shareholders can exercise their rights to buy more shares at a discounted rights. Buy doing this…it dilutes the power of the takeover company. Why you would use it…it makes it uneconomic… therefore, you can get the target company to come talk to you…and you can get rid of the rights (redeem)…only if say… The takeover company is willing to rise the premium price to say… $75 from $50…this will change the dynamic of the situation because now the takeover company will have to put out more money than they planned on doing.
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Tender Offers/Takeover Bids;
defensive strategies: Greenmail |
situation where target company may go to the takeover company and say… what will it take to make the takeover company go away. It’s where you pay them off…pay them to go away. Now put yourself in the shareholder’s shoe…how would you feel about that? you could have sold your tender shares, but now because you company paid the takeover company $$$ to go away…u can’t sell you shares…furthermore, the company loses money. In this event, you can sue for a shareholder derivative suits…where the company has breach their duty of loyalty because they are being selfish and not for shareholders
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Tender Offers/Takeover Bids;
defensive strategies: Issue treasury shares |
they are issued shares held by the company. They can put it in the hands of a friendly company (ex. employee stock ownership plan) where it would be hard for the takeover company to reach and get the 51%
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Tender Offers/Takeover Bids;
defensive strategies: Shark repellant statutes |
where (ex. Ohio has it) they help local companies to repel takeover…they have things like evaluation provision where a company can not offer a tender for a company in Ohio until you offer an amount of money according so some kind of formula…making it expensive for other companies to takeover. They do this to protect local companies…for ex. a company from japan might come in and buys a local company and then relocate the company to another state or country.
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Tender Offers/Takeover Bids;
defensive strategies: White knight |
if you don’t like the takeover company…you find another company to get onto the bid…there’ll be competition. When there’s competition…the buyout price will go up for the shareholders. For management… if they can find another company that would keep them in place if another company they like (the white knight) takes over than they’ll pursue that company.
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Tender Offers/Takeover Bids;
defensive strategies: Supermajority |
What management can do is change bi-laws to make it difficult…ex. change the laws so that instead of a 51% would be the majority…it’s now a supermajority…like 75% would be the majority. It’ll make the takeover company pay more (by buying more shares) to get 75%. It can hamstring business
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Tender Offers/Takeover Bids;
defensive strategies: Bankruptcy aka scorched earth |
where you make your company look bad to discourage the takeover company from investing in you. It’s quiet easy to do.
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Tender Offers/Takeover Bids;
defensive strategies: Pac-man |
if they make a tender offer to you… you can make a tender offer back. All it takes is access to capitals…if they can get together lenders.
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Tender Offers/Takeover Bids;
defensive strategies: Selling a crown jewel |
where the takeover company wants to takeover for a specific reason. Ex. they want access to your patents. So then the company can sell the patent and the takeover company will not takeover the company. You can sell and retain the rights to use it…but doesn’t own it anymore. Now, if you’re a shareholder and the company important assess is the patent…how you would feel?? And if the company sells it less than what it’s worth? Can file a derivative suit for corporate weight…suing those involve
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Tender Offers/Takeover Bids;
defensive strategies: Filing delaying lawsuits |
can hold up a lot with lawsuits…especially with a friendly judge… can slap an adjunction on the tender offer…just need to show the facts that when the company takes over…. You’ll be harm. A lot of these are time sensitive… if the court case is long…it discourage the takeover company... Therefore, you can delay a lawsuit so that it really really discourage the takeover company from taking over.
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Tender Offers/Takeover Bids;
defensive strategies: Create an ESOP (employee stock ownership plans) |
putting shares in the hands of a friendly company
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Securities Fraud
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Section 10(b) of 1934 Act and Rule 10(b)-5- one of the primary purposes of the 1934 Act was full disclosure of all material information to potential investors. This section was intended to cover all forms of fraud in connection with the sale or purchase of any security.
Security fraud has a number of forms. Central banks… supposed you’re the buyer and the company made a misrepresentation and behind the company, there’s a lot of third party that helps the firm (ex. accounting firms, law firms), they are behind the scene… the company made a misrepresentation and you sue the company for security fraud, but the bank doesn’t have $$ at what circumstance can you reach behind and get the guys in the back. They are aider and abettor…behind the scene….it is a criminal act in the 33 act, they would be criminally liable…but this is in the civil where you are suing for damages. If there’s fraud committed…and you have some thousand shareholders…if one can reach over and this is a class action…it could put those accounting firms our of business really fast. That’s a huge exposure…therefore, u’ll have to be careful on when the shareholders can reach over. Central bank said that you cant reach to them unless they are primary parties…where they made some kinds of direct connection with the buyers…it’s rarely the case because the company makes direct contact…not the third party. Central banks are not popular in the court circuits |
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stoneridge case
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Security fraud
it involves Charter who’s in the cable business. They buy cable boxes from two companies…Motorola and Scientific America. Here’s the problem…both companies overcharge for the cable boxes on the agreement that they’ll remit the money back to charder on a marketing expense. Ex. they charge you $150 instead of $120 (real price)…they take the difference and remit it back to charder in the form of marketing expense. The problem is that the expense that charder paid for the boxes was amortized. They didn’t take the expense all now, but spread over time. So then the marketing expense where taken into income at charder… they created a market expense and reported as their income. They amortized the box at 10 years. This misrepresented their company’s earnings by 17 million dollars. Is it accurate for prospective shareholders? No. Because it only inflated in earning by $17 mil, when it’s not here. The question is…can motorla and scientific america be liable for this? Sure. Did both company know what’s going on? Yes…they knew it. Should they be liable for security fraud?? The court said no, they are not liable, they were relying on central bank. The plaintiff (stoneridge) did not allege that the vender (motorla and scientific america) were not directly involve with the financial statement. The plaintiff didn’t allege that the misleading statements made in the complaint where seen or review by those venders. And that those two venders had no responsibility to disclose anything to the shareholders of charder. Therefore, the court is going to rely on central bank and not impose any liability on the two companies. Note… these two are aider and abettor… but only in common law will they be criminals. |
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Dan bailey case
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security fraud
doing a transaction deal knowing it’s not real…went along with it or enron (one of the biggest company) will switch investment banks…anyhoo, he got convicted, but won on appeal |
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Insider Trading
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The use of material, non-public information received from a corporate source by someone who has a fiduciary obligation to shareholders and potential investor and who benefits from trading on such information.
Who are the “insiders?” 1. Officers and directors 2. Investment bankers 3. Attorneys 4. Auditors 5. Printers 6. Martha? Why is it fraud?? Insider trading in the stock…base on information that are known to insiders…info. that’s have not been released to the public. It must be material… material means market moving information... information that’s significant to an investor when deciding to buy or sell stock. Something major. Insiders… traditionally, an officer…that is aware of information that have not yet be release. They are ppl who knew say…the earnings for the company. However, officers can not take advantage of the information by going out and buying the company’s stock…knowing that it will go up in a couple of days. The officers have fiduciary obligation to the shareholders…instead of themselves. example of insider trading besides Martha Stewart case Supposed you’re on the golf course and a guy tells you to buy Qualcomm…so you go out and buy Qualcomm… the next day…it goes up. Is that insider trading??? No, unless he said who he is, give you his business card…and tells you that he wants to give you an informational give. How about another guy tells you insider information…ex. they are in-play… and that you should sell your stock. The word in-play…might not be insider trading…but close. How about you know inside information and you tell your mom…so she does. Would that be guilty of insider trading??? Yes…there’s a tipper and a tippee. Many ppl think that they will only catch the big fish…not the small guys… there’s probably not going to get you..so why not?? What if they do get you?? 10b can get you a felony…it’s civil and criminal …that’s 5 years in prison. bn Insider Trader Sanctions Act of 1984: An act that increased the penalties against persons who profit from illegal use of insider information. The act allows the SEC to seek fines of up to three times the profits gained or losses avoided by those insiders who improperly use material nonpublic information. The act also increases from $10,000 to $100,000 the criminal penalties for market manipulation, securities fraud, and certain other violations. The act does not define "material inside information" or limit its prohibitions to corporate insiders. Anyone who helps another person to violate the insider trading rules can be held liable. |
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Martha Stewart case
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insider trading
one of her friends…Sam Waksal who was the CEO of Imclone (big biotech company). Imclone had a drug application reviewed by FDA which fights cancers. When a big company have an application in the FDA…and it gets approve… the stock price will go up greatly. Waksal had accessed of the FDA information. Once he knew that the FDA was going to disprove it he contacted Martha through their broker Peter Bacanovic peter notify Martha and she sold it before the market knew that the FDA was going to disprove the drug. The FDA then investigates the large sum of trading…so they goes back to the point of when the info. was just about to be released…and they identify the party that sold shares right before the release of the info. Martha name came up. Then the justice department contact her and asked if it was made on insider trading. She said no, her trade was made on a program agreement (cover by section 10b5-1). Program agreements are put in place where you sell and buy stocks on a preset formula. So you buy and sell not base on insider info., but on a program. Her broker backed (p. Bacanovic) her up saying she had a program agreement. They then talked to Douglas Faneuil who was Bacanovic assistance. He had some interaction with Martha…she didn’t like him…she referred to him as little Bacanovic’s shit. They made him a deal that if he comes clean…he’s not going to do prison for fraud. So then he testified saying that she did not have a program agreement… that’s destruction of justice… that’s what she’s convicted for. She was convicted for 5 months in prison. That’s an example of insider trading. Walsal is the tipper (guilty of security fraud) and martha is the tipee (also guilty of security fraud)…however, Martha does not work for imclone so how could she have fiduciary obligation?? Well, it’s Sam Walsal who has fiduciary obligation and when he tells someone that he’s the CEO… they inherit his fiduciary duty to the shareholder of imclone; therefore, making her guilty of insider trading. |
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name key players in Martha Stewart case
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Sam Waksal who was the CEO of Imclone
Peter Bacanovic- Stewart broker Douglas Faneuil who was Bacanovic assistance... testified that Stewart didnt have a program agreement |
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treble damages
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whatever you made off of the fraud, you’ll have to pay back 3-times that amount
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Program agreement
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For ppl who have insider information...you can direct a trustee to buy or sell the stock accords with pre-establish formula. You can’t change formula. Therefore, you can buy the company’s stock regardless of what was going on with your company.
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insider trading:
Option commit to play/back dating |
in the event where one back date an option. Ex. the option date given to corporate officer was on 10/15 and the stock was selling at $25 (issuing state) which becomes the strike price $25. they then back date the option to 9/15 when the stock was selling at $15 which became the strike price. The problem is that stock options is an incentive compensation. You’re supposed to have a strike price on the day the options is issued in that the incentive is to improve the company earning per share (want it to go up) and want stock price to go up… options are then in the money. But if you back date back on the issuing option…then you’re $10 ahead. A lot of company did this…including apple…they back dated it for the CEO
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insider trading:
Spring loading |
is where the company knows, say GE knows that it’s going to sell every city? Saving? 20:14. and target date is 12/1. and they are anticipating that when the info goes public…the stock price is going to go up. So what they do is spring load by issuing option on 11/30. when the stock price is $20 and they know that on the following day, when it’s released…the price will go up. Same category as insider trading where they are breaching duty with shareholders.
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insider trading:
misappropriation |
the court wants to extant 10b beyond traditional insiders, traditional insiders of GE would be corporate officer or director. There were situations the court wants to extend the rule by a theory called misappropriation
Usually most of the misappropriation happens when the inside info and the buy/sell of stock must happen at a close time. It would not be so if say you get the info in January and you buy/sell stock in November. |
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U.S. v. Winans and Carpenter
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insider trading; misappropriation
trading on misappropriated information Winans work for wall streets journal. Where the journal has a section called “heard on the streets: rumors”…and being that it’s the wall streets journal…it’s usually accurate. So when the section can move stocks when it becomes public…it can make the stock market go up or down. Winans took advantage of that…he traded in stocks mentioned on “heard on the streets.” before the paper goes public. This is not the traditional insiders because he’s not an officer of the company…instead it was from an article…therefore it’s misappropriation. Although he had no fiduciary to the company’s shareholder, he has fiduciary to the newspaper…not to trade on confidential info before the paper was published. The court found him guilty of insider trading |
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US v. O’Hagan
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insider trading; misappropriation
trading on misappropriated information he was a lawyer in Dorsey & Whitney where the company was representing Grand Metropolitan and unknown to the public, they were planning to take over Pillsbury Company. Once the company is targeted, the stock price of the target company goes up because the company that wants to take over bid more for the stock in order to get shareholders to sell their shares. Although O’Hegan didn’t work on that case, he overheard it and bought Pillsbury stocks and when the info was released that Pillsbury is going to be taken over, the stock price goes up. Even though he wasn’t an officer of the Pillsbury, he still owes a fiduciary to his law firm. Using the misappropriation theory…He breach it and is regard as insid trading. bn The Securities and Exchange Commission (SEC) found James O'Hagan, a partner at Dorsey and Whitney law firm (Dorsey), guilty of 57 counts of fraud for profiting from stock options in Pillsbury Company based on nonpublic information he misappropriated for his personal benefit. O'Hagan knew that Dorsey's client, Grand Metropolitan PLC, was considering placing a tender offer (a public offer to pay shareholders a premium for their stock at a specified time) to acquire a majority share in Pillsbury Company. O'Hagan bought a large number of stock options without telling his firm and later sold his options for a $4.3 million profit. The U.S. Court of Appeals for the Eighth Circuit reversed O'Hagan's convictions under the Securities Exchange Act of 1934. The Eighth Circuit applied the Act only to security-traders who wrongfully use confidential information pertaining to their own companies. The Circuit Court ruled that the SEC had exceeded the rule-making authority granted to it by the Act by making it a fraudulent action to trade securities on exclusive non-public foreknowledge of a tender offer. Conclusion: Justice Ruth Bader Ginsburg authored the opinion in the Court's 6-3 decision. The Court ruled that a security-trader who fails to disclose personal profits gained from reliance on exclusive information is guilty of employing "a deceptive device...in connection with the purchase of a security." The security-trader knowingly abuses the duty owed toward the source of information, whether the source is the company he works for or not. The Court also held that the SEC has authority to "define and prescribe means reasonably designed to prevent fraudulent...acts...in connection with any tender offer." Rule 14e-3(a) of the Exchange Act, adopted under this fraud-prevention authority, forbids security-traders from trading on the basis of information they know should be kept private unless they publicly disclose their trades. |
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U.S. v. Falcone
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the stretchability of the misappropriation theory
Falcone case which was the farthest the theory of misappropriation ever extent. You have the Business week which publish similar things to the wall streets journal… they also have rumors, prospects under the article name “inside wall streets. Business Week sent their gallery proof out to apply graphic to be printed, then it goes to Curtis publishing then to Hudson News. Mr. Falcone made a deal with someone on the loading dock at Hudson News to give him the Business Weeks before it goes public. He then traded the on the info that he got from the News. The court said that fiduciary duty worked its way up the line…therefore, Falcone was found guilty. bn U.S. v. Falcone One who sells materials knowing that they are intended for use, or will be used, in the production of illicit distilled spirits, but not knowing of a conspiracy to commit the crime, is not chargeable as coconspirator. |
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Corporate Mismanagement
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any reports released financial statements containing material info as coverage. It means that the annual reports, 10K, period reports, press releases, when CEO is on TV…any of those constitute info that could result in a security fraud case. Ex. Martha Stewart Enterprise is Martha Stewart…Martha Stewart enterprise without Martha would be worthless…if she goes to jail then the stock would go down. She held a press conference and she said she’s not guilty. Now supposed you own stocks and you’re watching on the sideline…now you buy her company’s stock cause she cleared the air about being not guilty. Then the real story comes out and she gets convicted and the stock price dropped… you lost money… who can you sue? Is that misrepresentation? Yes… that’s material…and intent to deceive. She lied….it’s a classic 10b case. Sometimes lawyers need to talk to corporate officers about things they could say and can’t so that the things they say in a press conference will not lead to misrepresentation.
note on slide Any report, release, financial statement or other statement contains material information is covered by 10-b. (Martha Stewart – “I made the trade pursuant to a program….”) Elements required for an action: transaction under attack involved purchase and sale of securities alleged fraud is in connection with such purchase or sale plaintiff is either a purchaser or seller [Hochfelder] |
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SEC v. Texas Gulf Sulphur
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corporate mismanagement case
Texas Gulf…old case… was a first came that involved tippy liability. The company was in mining business. Something you don’t know how good the land is until you do the drilling. as it turns out, the finding was really good. When they were asked publicly if the finding was good and they said no. Saying no because they wanted to buy stock options. As the stock comes out, their press six month later said that their findings was very good making stock go up. This is considered insider trading…they tipped family members bn SEC v. Texas Gulf Sulphur FACTS TGS conducted exploratory activities in eastern Canada. These operations resulted in the detection of a significant amount of commercially mineable ore. Rumors of the ore strike began circulating throughout Canada. TGS issued a press release denying having struck ore and stating that the rumors were only speculation. Between the time of the press release (April 12) and the dissemination of the TGS official announcement (April 16), two of the defendants purchased TGS stock. Issue(s) Whether the transactions in question were made in violation of Rule 10b-5. Holding and Reasoning Yes. All transactions in TGS stock or calls by individuals apprised of the drilling results were made in violation of Rule 10b-5. Knowledge of the results of the discovery would have been important to a reasonable investor and might have affected the price of the stock. Before insiders may act upon material information, such information must have been effectively disclosed in a manner sufficient to insure its availability to the investing public. All insider activity must await dissemination of the promised official announcement. |
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Corporate Mismanagement:
Balance sheet fraud |
it’s the numbers. It’s very easy to have fraud here to inflate earnings. A lot of companies have quarterly reports so they all want to hit their numbers… it leads to the temptation for them to go back and play with the numbers to make their number. Ex. Curis wires?? They make organ… they forge customer’s signatures on purchase orders…sale that didn’t exists, they took it into earnings. Sometimes, you ship produces and take it into earnings even when the customers haven’t paid yet… is it a sale?? it’s contingent…it shouldn’t have taken into pay.
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Corporate Mismanagement:
Channel stuffing |
lots of drug companies do this…Crystal Meyer…inflated their earning by 2.75 billion dollars. You’re getting to the end of your quarter and you panic because it will affect you…so you call up your usual customers and ask them to buy the stuff for this quarter instead of next quarter and they can play next quarter…that’s channel stuffing…taking shipment from next quarter and bring it back to the current period and writing it down as earnings when it’s really not recognized as an earning. It’s earning when the other company orders it and paid
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Corporate Mismanagement:
Ragtime case |
they opened it in LA and want to move it to NY. But ppl in NY wont want them if the show is not hit. Furthermore, no one goes to the show in LA so the director buys the show every show time. They did this by amortization… they spread it over time so that the sum of money doesn’t show up on record. So that their financial statement does not seem suspicious. This is fraud
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Corporate Mismanagement:
cookie jar |
A "cookie jar" is an expression used to describe the technique of overstating
the reserve accounts with the thought of reversing those accounts when the company wants to manufacture earnings. In other words, the earnings are not real; they are bogus |
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Corporate Mismanagement:
Earnings management |
different than what Sunbeam did. a company getting into the end of the quarter, and the company is going to exceed the predicted number that was predicted (good), so they put $2 million into a reserving account which in the end…meets the predicted number. Then the following year, the company doesn’t do too well, so they reach into their reserved and take out the $2 mil. By doing this, they are able to reach their predicted number. This is not illegal compared to Sunbeam because there’s proof of the money… they can back it up not like Sunbeam who made up the number. A lot of company does this…Microsoft leveling their earnings so it’s nice and smooth. They want to make earning goes up but not rock it.
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Short swing profits
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any officer or director or holder holding 10% of stocks have to report (to SEC, wall street journals) within 3 days when they buy or sell the stocks. It’s important because ppl want to know what the big shots are doing…if they sell all, it might be bad.
Section 16(b) – requires officers, directors and 10% owners to file an initial report of holdings and then to supplement within 3 days where there is a change in their holdings. Any profits made within a 6 month period is a short swing profit and presumptively based on insider information and can be recaptured for the benefit of the corporation. |
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Greenfield v. Fritz Companies
Note: case was not mention in lecture but is on his ppt slides |
Fritz Companies, a publicly traded corporation, omitted material information about the financial prospects of the corporation. On July 24, 1996 Fritz revised its earnings downward and the shares dropped more than 55% in one day.
Greenfield is a shareholder. He filed a class action against Fritz and several directors for fraud. The trial court sustained defendants demurrer to the complaint. HELD: In California, fraud must be pled specifically; general and conclusory allegations do not suffice. This particularity requirement necessitates pleading facts which show how, when, where, to whom, and by what means the representations were tendered. Greenfield has not failed to satisfy the requirement of particularized pleading. His allegations are more than adequate. Misrepresentations concerning the same type of financial information at issue here have been accepted as fraudulent and actionable. There is no reason in either law or logic why the same result should not apply to a situation where corporate stockholders are fraudulently induced to retain or refrain from selling their shares. Experience may demonstrate that plaintiff’s cause of action entails difficulties or defects that outweigh its utility. |
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Basic Incorporated v. Levinson
Note: case was not mention in lecture but is on his ppt slides |
Facts
TGS conducted exploratory activities in eastern Canada. These operations resulted in the detection of a significant amount of commercially mineable ore. Rumors of the ore strike began circulating throughout Canada. TGS issued a press release denying having struck ore and stating that the rumors were only speculation. Between the time of the press release (April 12) and the dissemination of the TGS official announcement (April 16), two of the defendants purchased TGS stock. Issue(s) Whether the transactions in question were made in violation of Rule 10b-5. Holding and Reasoning Yes. All transactions in TGS stock or calls by individuals apprised of the drilling results were made in violation of Rule 10b-5. Knowledge of the results of the discovery would have been important to a reasonable investor and might have affected the price of the stock. Before insiders may act upon material information, such information must have been effectively disclosed in a manner sufficient to insure its availability to the investing public. All insider activity must await dissemination of the promised official announcement. |
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offering circular
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also called prospectus or circular.
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fair disclosure
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regulation FD (fair disclosure), passed by SEC, there was a problem before FD… the company would invite in the analysis and disclose whatever it is in the morning, then in noon, the company disclose it to the public. So with a 2 hrs. gap there’s an advantage….he analysis can buy/sell the stock before the info. Are disclosed to the public. Therefore, the FD is where you have to release the disclose info at the same time to both the analysis and the public.
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