CH-23-25 Rules Governing the Issuance and Trading of Securities – The Legal Environment of Business: A Critical Thinking Approach : Book Guide

This Document Contains Chapters 23 to 25 Chapter 23 Rules Governing the Issuance and Trading of Securities Introduction Chapter Twenty-Three addresses these questions: • What role do federal and state governments play in regulating securities? • What is the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010? • What is the Sarbanes-Oxley Act of 2002? • How are the Securities Act of 1933 and Securities Exchange Act of 1934 related? • What rules apply to the various actors in the state securities laws? • How are e-commerce, online securities disclosure, and fraud regulation related? • What are the global dimensions of rules governing the issuance and trading of securities? Chapter Twenty-Three is significant because regulations that affect the area of securities law protect the integrity of free markets. The securities field needs to be protected from fraud and other problems so that Americans will continue to invest in companies. The securities industry is one that managers want to protect through necessary rules and regulations. In regulating, the government provides protections to managers as investors, and as individuals who want to continue to work for financially secure companies. Achieving Teaching Excellence Exciting Audiovisuals—Using Slides and Music to Enhance Classroom Experiences An article by Peter Frederick presented good ideas about how to promote active learning in class. Frederick, a history professor presented several ideas for promoting active learning in history classes. One works particularly well in legal environment of business classes. Frederick presented a section on using slides and music in class to evoke students’ emotional learning. First, this section of the Instructor’s Manual will present a summary of the section of Frederick’s article on affective learning with audio-visual media. Second, this section will take some of Frederick’s ideas and present ideas about how to modify them for use in the legal environment of business classroom. Frederick describes examples of how to use emotion in class to motivate students, set the tone for a topic, raise questions, and encourage rethinking. He writes that “emotional experience leads to cognitive insights.” Then, he gives several examples of how to use audio-visual media in class. Some of his examples are as follows: 1. Establish a mood for a particular class period by showing slides. Or, as students walk into class, let them hear a speech or music that relates to course material for the day. Also, the instructor might want to put several powerful short quotations on a transparency. 2. Go one step further and combine some of the ideas above. Combine a piece of music with slides. Synchronize one or two slides with each lyrical line of a song. Frederick explains how music and slides are intensely active experiences for students. He advises instructors to be careful as they evoke emotional as well as intellectual responses from the students. He advises instructors to respect the students’ need for privacy. Frederick suggests that quiet writing time and talking in pairs can provide students with space they might need to think through their responses to the audio-visual material. Finally, he reminds instructors that his goal is to structure “ways of empowering students to discover, and own, historical knowledge, skills, and attitudes for themselves and to feel good about themselves as learners.” How can instructors use Frederick’s ideas in their classes? Is it even possible to take some of his ideas and use them with a topic as securities regulation? First, it is important to recognize that some areas of law evoke more emotional responses than others. Labor law and constitutional law probably trigger more emotions than contract and antitrust law. Thus, this idea for improving what happens in class will work better in some chapters of the legal environment of business than others. Still, it is possible to use some of Frederick’s ideas in parts of the book that seem less inspirational. For instance, instructors can do some active learning by using some of Frederick’s ideas … even in the current chapter about securities regulation! It might be a challenge to create slides for use in this chapter, but it would be easy to bring in sections of a few videotapes that relate to this section’s materials. One choice would be excerpts for the movie Wall Street, although this movie is old enough now that students might not even relate to the idea that “greed is good.” A more recent movie, Startup.com, might yield some good conversations about securities law. This documentary, released in 2001, tells the story of Tom Herman and Kaleil Isaza, who start their own Internet business, govWorks. This movie shares the development of the business by two hardworking entrepreneurs, and their rapid descent into failure. It would be interesting to raise questions about what happened to the investors when the business failed. Another idea would be to put several short, powerful statements from court cases about securities fraud on a transparency. Instructors could put several strong statements that show the damage fraud can inflict on investors and the market in general. Once instructors start looking, they might be surprised at how many sources of great audio-visual material are available. The Internet certainly makes it easier to find good sources. The instructors could start by doing an audio-visual activity for one or two chapters during the term. They should experiment. Frederick’s idea of combining the audio-visual activity with an in-class writing assignment is one that most instructors would like. Good luck! This section has presented one more idea for achieving Teaching Excellence! References • Peter Frederick, “Active Learning in History Classes,” 16 TEACHING HISTORY 67 (1991). Chapter Overview, Topic Outline, and Discussion Questions Chapter Overview Both because of their importance to the operation of the United States’ free enterprise society and because of the ease with which they can be manipulated, securities have been regulated by governments for nearly a century. This chapter chiefly examines the role of the federal government in regulating securities. It introduces the subject with a brief history of securities regulation that contains a summary of the most important federal legislation. Then, the chapter turns to the creation, function, and structure of the Securities and Exchange Commission (SEC). In a survey of major and representative securities legislation, it examines the provisions of the Dodd-Frank Act of 2010 and the Sarbanes-Oxley Act of 2002. Both the Securities Act of 1933, which governs the issuance of securities and outlines the registration requirements for both securities and transactions (and the allowable exemptions from those requirements), and the Securities Exchange Act of 1934, which governs trading in securities, are discussed. Next, the chapter examines the state securities laws and online securities disclosure and fraud regulations. It ends with a discussion of the global dimensions of the 1933 and 1934 securities acts and the Foreign Corrupt Practices Act. Finally, the chapter briefly examines the Convention on Combating Bribery of Foreign Officials in International Business Transactions This chapter packs a great amount of detailed, technical information into one important chapter. It will be important for the instructors to establish priorities for the class in what they expect the students to absorb in the way of details. When instructors use this chapter, they should encourage students to learn ideas and general concepts, and do not expect them to remember things like the names of the forms businesses must file under the 1934 Act. The discussion questions are the focus of class discussion. The instructors should focus more on the cases because they present interesting fact situations and important legal concepts. Instructors might want to consider emphasizing the material that describes the Securities Exchange Act of 1934. This material is especially important to business managers. Topic Outline I. Introduction to the Regulation of Securities A. Summary of Federal Securities Legislation B. The Securities and Exchange Commission Creation and Function Structure Division of Corporation Finance Division of Market Regulation Division of Enforcement Division of Corporation Regulation Division of Investment Management II. Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 A. Oversight of Financial Problems by Regulatory Agencies B. Risk Taking by Large Banks and Nonbanks C. Executive Compensation D. Too Big to Fail E. Credit Rating Agencies F. Derivatives G. Consumer Protection H. Exemptions I. Regulation of the Regulators by a Court of Law III. The Sarbanes-Oxley Act of 2002 A. Corporate Accountability B. New Accounting Regulations C. Criminal Penalties IV. The Securities Act of 1933 A. Definition of a Security Common Enterprise Reasonable Expectations of Profit Profits Derived Solely from the Efforts of Others Securities and Exchange Commission v. Edwards B. Registration of Securities under the 1933 Act Purpose and Goals Registration Statement and Process Disclosure Prefiling Period Waiting Period Posteffective Period Communications Shelf Registration C. Securities and Transactions Exempt from Registration under the 1933 Act Private Placement Exemptions Intrastate Offering Exemption Small Business Exemptions Other Offering Exemptions Exempt Securities D. Resale Restrictions E. Liability, Remedies, and Defenses under the 1933 Securities Act Private Remedies Misrepresentations in a Registration Statement Failure to File a Registration Statement Misrepresentation or Fraud in the Sale of a Security Governmental Remedies Administrative Action Injunctive Action Criminal Penalties V. The Securities and Exchange Act of 1934 A. Registration of Securities Issuers, Brokers, and Dealers Registration of Securities Issuers Registration of Brokers and Dealers B. Disclosure: Compensation C. Securities Markets D. Proxy Solicitations Procedural and Substantive Rules Shareholder Proposals Proxy Contests E. Tender Offers and Takeover Bids Rules Governing Tender Offers F. Remedies and Defensive Strategies Remedies Barbara Schreiber v. Burlington Northern, Inc. Defensive Strategies G. Securities Fraud Section 10(b) of the Securities Exchange Act Stoneridge Investment Partners, LLC, et al. v. Scientific-Atlantic Inc., et al. Insider Trading and Section 10(b) of the 1934 Act Misstatements of Corporations and Section 10(b) Securities and Exchange Commission v. Texas Gulf Sulphur Co. Corporate Mismanagement and Section 10(b) Fraud-on-the-Market Theory and Section 10(b) H. Liability and Remedies under the 1934 Exchange Act Criminal Penalties SEC Action Private Actions The Wharf (Holdings) Limited v. United International Holdings, Inc. I. Short-Swing Profits Purpose and Coverage Liability VI. State Securities Laws VII. E-Commerce, Online Securities Disclosure, and Fraud Regulation A. Marketplace of Securities B. E-Commerce and Fraud in the Marketplace VIII. Global Dimensions of Rules Governing the Issuance and Trading of Securities A. Legislation Prohibiting Bribery and Money Laundering Overseas The Foreign Corrupt Practices Act of 1977, as Amended in 1988 Convention on Combating Bribery of Foreign Officials in International Business Transactions The International Securities Enforcement Cooperation Act of 1990 B. Legislation Governing Foreign Securities Sold in the United States C. Regulations and Offshore Transactions IX. Summary Discussion Questions for Chapter Twenty-Three 1. Explain relationships between the Securities Act of 1933 and the Securities and Exchange Act of 1934. The primary difference between the two laws is that the 1933 Act regulates the initial public offering of securities, whereas the 1934 Act regulates the trading of securities. Another relationship is that the 1934 Act accomplishes more than the 1933 Act. In addition to its primary purpose, the 1934 Act also requires brokers and dealers trading in securities to register with the Securities and Exchange Commission (SEC). It also created the SEC to enforce both the 1933 and 1934 Acts. 2. Explain relationships between the Foreign Corrupt Practices Act of 1977 (FCPA) and the International Securities Enforcement Cooperation Act of 1990 (ISECA). The FCPA prohibits the direct or indirect giving of “anything of value” to a foreign official for the purpose of influencing his or her actions. The ISECA clarifies SEC authority to provide securities regulators of other governments with documents and information. It also exempts from the Freedom of Information Act disclosure requirements of documents given to the SEC by foreign regulators. ISECA also gives the SEC authority to impose administrative sanctions on buyers and dealers who have engaged in illegal activities in foreign countries. The ISECA finally authorizes the SEC to investigate violations of the securities law set out here which occur in foreign countries. One relationship between the two is that both help protect the international dimensions of securities law. 3. Evaluate this statement: The Securities and Exchange Commission (SEC) evaluates the worth of a public offering of securities by a corporation. This statement is inadequate because the SEC does not evaluate the worth of a public offering. Instead, the SEC tries to make sure investors have complete, accurate information so they can determine for themselves the worth of a public offering. 4. Evaluate this statement: It is easy to tell whether something is a “security”. One would just have to look at it carefully. This statement is inadequate because sometimes it is very difficult to tell whether something is a security just by looking at it. For instance, it would be difficult to look at the sale of rows of orange trees to the public with a service contract and know it is a security. To determine whether something is a security, the Howey test is applied. This test looks at whether the contract or scheme is one in which individuals invested in a common enterprise, whether investors had a reasonable expectation of profits, and whether the profits were derived solely from the efforts of those other than the investors. 5. Explain relationships between the prospectus and Part II information statement. Both the prospectus and the Part II information statement are parts of the registration statement that meets the disclosure requirements of the 1933 Act. The prospectus describes a new security issue. Part II consists of a longer, more detailed statement, which is not given to prospective buyers but is open for public inspection at the commission. 6. Explain relationships between the Securities Act of 1933 and shelf registration. The Securities Act of 1933 regulates the initial issuance of securities. Shelf registration is one specific kind of registration the law permits. Shelf registration allows a corporation to file a registration statement for securities that it may wish to sell over a period of time rather than immediately. Once the security is registered, the corporation can place it on the “shelf” for future sale and not have to register it again. 7. What basic rationales underlie the exemptions to the 1933 Securities Act? The exemptions assume that some people do not need the government to require full, accurate, complete information before they decide whether to invest in a particular company. For instance, in a private placement of stock, investors are sophisticated and know the company, so they do not need the SEC’s protection. Another rationale is that some companies are so small they could not afford to go through the registration process. The small business exemption says that offerings not exceeding $5 million are exempt when the SEC finds registration is not necessary. 8. Explain relationships between the due diligence defense and the business judgment rule. The business judgment rule protects directors and managers from poor decisions, as long as they make decisions that reflect good faith. The due diligence defense is much less forgiving to officers, directors, and anyone who signs a registration statement that includes misstatements or omissions. The due diligence defense claims a defendant has reasonable grounds to believe that all statements in the registration statement are true and no omission of material fact has been made. Escott v. BarChris shows the difficulty of using this defense successfully. Therefore, one must be much more careful with registration statement decisions than business decision making in general. 9. Explain relationships between proxy solicitations and takeover bids. One relationship between proxy solicitations and takeover bids is that both are regulated by the Securities Exchange Act of 1934. Section 14 of the Exchange Act sets forth the ground rules governing proxy solicitations by inside management, dissident shareholders, or potential acquirers of a company. Takeover bids are regulated by Sections 13 and 14 of the Exchange Act. 10. Explain relationships between insider trading and misstatements of corporations. Both insider trading and misstatements of corporations are specific kinds of securities fraud under Section 10(5) of the exchange act. Insider trading is the use of nonpublic information received from a corporate source by an individual who has a fiduciary obligation to shareholders and potential investors, and who benefits from trading on such information. Misstatements of corporations include any report, release of financial statement, or any other statement, that is released by an officer, director or employee of a corporation in connection with the purchase or sale of a security that shows an intent to mislead shareholders or potential investors. 11. Explain relationships between insider trading and fraud-on-the-market theory. Both insider trading and fraud-on-the-market theory are specific kinds of securities fraud banned by Section 10(b)-5 and Rule 10(b)-5 of the 1934 Act. The fraud-on-the-market is a relatively new and creative theory compared to insider trading. It is also a less specific theory. The fraud-on-the-market theory allows shareholders to allege that they relied on the integrity of an efficient market to assimilate all information about a company to reflect this information in a fair price for securities. The plaintiff argues that when a company makes fraudulent disclosures or omissions, it distorts the information flow to the market and thus fixes the price of the company’s securities too high. 12. Evaluate this statement: Congress has defined “insider trading” clearly. This statement is inadequate because Congress has refused to define insider trading. Instead, courts have developed definitions through case law. Instructors could ask students why Congress would not want to define insider trading. 13. Evaluate this statement: States are not allowed to regulate in the area of securities law. This statement is flawed. State regulatory agencies are not preempted from regulatory authority by the federal government. Securities may be subject to both state and federal rules. 14. Why are global dimensions of securities law especially important? People invest and trade in securities internationally, and some people put their fraudulently obtained profits in foreign banks. Thus, international dimensions are especially important because people have to respond to situations involving fraud throughout world markets. Answers to Critical Thinking about the Law Questions, Case Summaries, Answers to Review Questions, Review Problems, and Case Problems Suggested Answers to Critical Thinking about the Law Questions 1. The ethical norm emphasized hers is security, defined as to achieve the psychological condition of self-confidence, such that, risks are welcomed. Jessica wants to make sure she doesn’t lose her money due to someone else’s dishonesty. Government regulators require companies to be honest. 2. First, it is important to know whether Buy-It-Here really misrepresented itself. It is possible the caller was not an agent of Buy-It-Here. Possibly, the caller was engaging in fraud on his own, and But-It-Here was also victimized by the fraud. 3. Here, the cases are similar because both women lost money in the stock market when a company they invested in went bankrupt. However, the two cases are different in such a significant way that Jessica cannot use Andrea’s case as an analogy. The key difference is that Andrea relied on the advice of a stockbroker, whereas Jessica made her purchase independently. In Andrea’s case, the stockbroker did not give Andrea all the information she needed to make a good decision. Andrea had a good cause of action against the stockbroker. Jessica did not rely on the advice of a professional. Instead, she relied on the sales pitch of a stranger who called her. A jury would not have much sympathy for someone so naive. Suggested Answers to Critical Thinking about the Law Questions—St. Patrick’s Day Bailout of an Investment Banking Firm (Bear Stearns, Inc.) by the U.S. Taxpayers 1. The government prefers the norm of security. Government actors wanted to bailout Bear Stearns to ease anxieties in the financial markets. The employees of Bear also want security—they want to know they will be okay after the bailout. They also want justice, defined as fairness. They want to get what they are due, as loyal employees. 2. This is a judgment call. Preferably, markets would weed out weak companies such as Bear Stearns. The complexity here, though, is that, if Bear had gone bust, the ripple effects might have been unbearable. Case Summary—Securities and Exchange Commission v. Edwards This case is in the book to illustrate how cases can be interpreted to define security. In this case, the Supreme Court had to decide whether an investment scheme that promises a fixed rate of return can be a security. The Court ruled that there was no reason to differentiate between an investment scheme that promised a fixed return and a scheme that promised a variable return because, in both cases, investors are attracted to promises of profits. Both types of return are considered investment contracts, therefore, they are securities. Case Summary—Barbara Schreiber v. Burlington Northern, Inc. In this landmark case, the U.S. Supreme Court interpreted the meaning of the Williams Act. The Court was concerned with the correct interpretation of the word “manipulative”, which is the basis for causes of action brought under Section 14(e). In this case, defendant Burlington Northern, Inc. won a case after the U.S. Supreme Court ruled that the company’s behavior was not manipulative. The company had rescinded a tender offer, and shareholders suffered. The shareholders lost. Suggested Answers to Critical Thinking about the Law Questions 1. The court tries to figure out what the word “manipulative” means. 2. To define “manipulative”, the Court looks to the purpose of the law and its legislative history. 3. The primary ethical norm that would be damaged if judges decided fairness would be efficiency. The number of court cases would go up, and judges would have to use more of their already limited resources figuring out whether certain behavior was fair. The Court wants to stay out of this kind of decision making to save both time and money. Case Summary—Stoneridge Investment Partners, LLC, et al. v. Scientific-Atlantic Inc., et al In this important securities law case, the U.S. Supreme Court rejected an argument that private investors can sue actors (e.g., accountants, lawyers, other businesses) that allegedly participate in a scheme to violate Section 10(b) of the Securities Exchange Act of 1934 and SEC Rule 10b-5. Stoneridge Investment Partners sued Scientific-Atlanta and Motorola for scheming with Charter in violation of securities laws. The Court said that investors may sue only those who issued statements or otherwise took direction action that the investors relied upon in buying or selling stock—whether that involved public statements, omissions of key facts, manipulative trading, or conduct that was itself deceptive. Suggested Answers to Critical Thinking about the Law Questions 1. Some of the reasons why the Supreme Court rejected the theory are as follows: • There was no sufficient link in the chain toward legal liability. • The plaintiff would have to prove reliance while making decisions of holding or acquire a security. • The §10(b) implied private right of action does not extend to aiders and abettors. The conduct of a secondary actor must satisfy each of the elements or preconditions for liability. 2. The defendants, Scientific-Atlanta and Motorola did not get away “free.” They had to defend themselves in a very important securities regulation case. Their reputations were tarnished. These companies were deceptive, which makes their acts questionable from a moral perspective. However, in order to win the case the plaintiffs would have to prove §10(b) private action satisfies the following: • A material misrepresentation or omission by the defendant • Scienter • A connection between the misrepresentation or omission and the purchase or sale of a security • Reliance upon the misrepresentation or omission • Economic loss • Loss causation Case Summary—Securities and Exchange Commission v. Texas Gulf Sulphur Co. This case has been included in the text as it deals with insider trading. The SEC filed a suit against the Texas Sulphur Company (TGS) along with 13 of its officers, directors, and employees for violating the Section 10(b) of the Exchange Act and SEC Rule 10(b)-5. TGS had acquired an option to acquire land 160 acres of land in Timmons, Ontario, where there were substantial amounts of copper and zinc in November 1963. As a result the NYSE barred stop orders in order to curb volatility in the stock market. Initially, officers, directors, and employees of TGS owned only 1,135 shares. After the drilling began, in March 1964, it was observed that the insiders and the tippees acquired an additional 7,100 shares and 12,300 calls. It was seen that when the confirmatory press release was issued, 10 insiders and their tippees made estimated profits of $273,892 on the purchase of their shares or calls of TGS stock. The federal court dismissed charges against all the defendants apart from two. Those two defendants appealed. Additionally, the SEC appealed as charges were dropped against nine individuals. Case Summary—The Wharf (Holdings) Limited v. United International Holdings, Inc. In this case, the Supreme Court ruled in favor of United, when it alleged securities fraud against Wharf. The Court stated that even oral contracts are covered by Section 10(b). The Court stated that “[t]o sell an option while secretly intending not to permit the option’s exercise is misleading, because a buyer normally presumes good faith.” Answers to Review Questions 23-1. Short-swing profits are a kind of insider trading. They occur when a director or someone with a fiduciary responsibility to other investors use insider trading methods within the first six months of being in their position. These profits are large. Insider trading refers to the use of material, nonpublic information received from a corporate source by someone who has a fiduciary obligation to shareholders and potential investors and who benefits from trading on such information. 23-2. The shareholder proposal may be excluded if under the particular state law, it would be unlawful if agreed to by the directors; it involves a personal grievance; it relates to ordinary operational business functions; it is not significantly related to a company’s business; the stockholder does not own a certain amount of stock; or the shareholder’s proposal received less than 5 percent of the votes when submitted the previous year. 23-3. The courts use the following criteria to determine whether an instrument or transaction will be called a security: • Whether there existed a contract or scheme whereby an individual invested money in a common enterprise • Whether the investors had reasonable expectations of profits • Whether profits were derived solely from the efforts of those other than the investors 23-4. All securities that meet the Howey test and do not fall under an exemption to the 1933 Act must be registered under the 1933 Act. 23-5. Securities are exempt from registration under the 1933 Act if they fall into one of the following categories: • The private placement exemption • The intrastate offering exemption • The small business exemption • Other exemptions, such as government securities issued or regulated by another agency Answers to Review Problems 23-6. Livingston will win. He does not perform policy functions. Instead, he handles day to day operations, so he does not fall under Section 16. 23-7. Bigelow Corporation uses the over-the-counter market and for this reason it does not require any qualification for membership. Under Section 6(b) of the Exchange Act, an exchange cannot be registered unless the SEC determines that its rules are designed “to prevent fraudulent and manipulative acts and practices” and to discipline its members for any violations of its rules or the securities laws. 23-8. The plaintiffs would be able to recover their money if they are able to establish that: • The transaction being attacked involves the purchase or sale of securities. • The alleged fraud is in connection with a purchase or sale. • The plaintiff is either a purchaser or a seller of securities in the transaction involved. 23-9. The statements are material if the information would affect the judgment of the average prudent investor. It is a question of whether the facts listed here would affect the probable future of the company. Some students will think that most investors would care about millions of dollars, even if the company is worth billions. They will believe that Schlitz was in the wrong. 23-10. The transaction seems to meet the Howey test. There is a common enterprise, a reasonable expectation of profits, and the profits are derived solely from the efforts of others. In fact, this situation is very much like the Howey facts—with the rows of orange trees accompanied by a service contract. 23-11. Continental will lose. The private placement exemption applies when the number of purchasers is 35 or less (here there are 38). Also, it is unclear whether the sellers have any reason to believe the investors can evaluate risks and benefits of the investment. Here, it is hard to know who the investors are, and the high-pressure atmosphere in the room doesn’t appear to encourage the sellers to discover whether the investors know what they are doing. Answers to Case Problems 23-12. Initially, the case was dismissed because the trial court found that Todman could not incur primary liability for securities fraud. However, the appellant court ruled that an accounting firm could incur primary liability if the auditor provided a false or misleading certified opinion, knew investors were relying on this opinion, and still failed to correct or withdraw its opinion. The appellant court decided that because the plaintiff’s were pleading this exact theory of liability, the trial court’s decision should be dismissed and remanded for further proceedings. 23-13. In this case the court found that NMC and Bleakney were ignorant of the unorthodox transactions that took place were that Bleakney had sold as well as purchased at his own convenience. For this reason, he was not entrapped by the merger or imposed to surrender or acquire shares involuntarily to match the transactions. For this reason, there is no basis of law or fact for treating Bleakney’s action as implicating the “unorthodox transactions” doctrine. 23-14. The appeals court reversed and remanded this case. In addition to that the court dismissed Northstar’s Federal Claims since the job of the enforcement was that of the SEC. Thinking Critically About Relevant Legal Issues 1. The author wants strict punishments because not only do those who commit fraud financially hurt a lot of people who trust them, but it also hurts the economy because people become afraid to invest. 2. The author provides no data, just broad concepts about why, in theory, white collar crime is very dangerous to the economy. 3. Some data about how often these crimes occur and how the economy has suffered because of these crimes and some statistics about how much the average investor lost in the most recent fraud, would be helpful in evaluating the worth of the author’s claims. All these would give credence to the author’s argument and help accent the broad, theoretical argument. 4. The section about the way the general economy is harmed is a little ambiguous. The author makes claims that need to be qualified in order for them to make sense. The connections the author makes are vague. 5. One could argue that many times, the investors are not completely sure of the extent of the problems. This is a capitalist system and insider traders are products of that system. They feel the need to make a lot of money at all costs. Chapter 24 Antitrust Laws Introduction Chapter Twenty-Four addresses these questions: • What is the purpose of antitrust law? • How are antitrust laws enforced, and what are the exemptions under the antitrust laws? • What does the Sherman Act of 1890 prohibit? • What does the Clayton Act of 1914 prohibit? • What other antitrust statutes do business managers need to understand? • What are the global dimensions of antitrust laws? Chapter Twenty-Four is significant because antitrust law ensures the functioning of free markets in the United States. The Sherman Act of 1890 has a significant impact on business conduct and management decision making. It is important for managers to understand this area of law because of its relationship to competition. Chapter Twenty-Four also explains important laws regarding price discrimination, tying arrangements, exclusive-dealing contracts, mergers and acquisitions, and interlocking directorates. These sometimes present complicated situations for businesses, especially ones that want to continue to grow. Managers must be aware of what behavior is legal, and what is not. This chapter is especially important in light of the government’s legal action against Microsoft. Achieving Teaching Excellence In-Class Writing At this point in the semester, instructors could engage in “discussion” with students using short, in-class writing assignments, rather than engaging in verbal exchanges with them. One characteristic of excellent teaching is that instructors show appreciation for students’ and their own need for variety in class. Using a critical thinking model goes well with in-class writing assignments. This section gives some examples of appropriate in class writing assignments. It gives examples that focus on the material presented in Chapter Twenty-Four of the textbook. In-Class Writing Assignment One—Using a Case from this Chapter—have students choose one of the cases the chapter presents that is not followed by critical thinking questions. At this point in the semester, students should be familiar enough with the critical thinking questions that they can write good questions on their own. Ask them to write three critical thinking questions for one of the cases that do not include critical thinking questions. In-Class Writing Assignment Two—A Debate Format—pick a case in the book. Ask students to write an argument in which they explain whether the facts of the case call for increased government regulation, or whether the facts suggest the need for either deregulation or no regulation. Tell students to identify the ethical norm that is most consistent with their argument. An additional assignment would be for students to trade arguments, and evaluate an argument written by one of their peers. These writing assignments allow active learning, encourage critical thinking, and allow instructors to see what students are and are not learning. Additionally, instructors get to vary the way they conduct their class. These ideas will help instructors move one step closer to achieving Teaching Excellence. Chapter Overview, Topic Outline, and Discussion Questions Chapter Overview This chapter begins with an introduction to the meaning of antitrust and a summary of the federal antitrust statutes. It then discusses enforcement of the antitrust laws and exemptions made to those laws. Next it examines the types of business conduct that are forbidden by the Sherman Act, as well as the Clayton Act, the Federal Trade Commission Act, and the Bank Merger Act of 1966. Because these acts have affected, directly and indirectly, almost every business and political institution in American society, and carry criminal and/or civil penalties, much of the chapter focuses on dissecting them. Finally, it examines the global dimensions of antitrust policy. Chapter Twenty-Four presents some interesting articles that help students understand how the goals of antitrust legislation change when people with different perspectives on the goals of antitrust legislation are in positions of power. Instructors should make sure that they have current knowledge about the Microsoft antitrust action. Students will want the latest information. Topic Outline I. Introduction to Antitrust Law A. A Definition of Antitrust B. Law and Economics: Setting and Enforcing Antitrust Policy C. Goals of the Antitrust Statutes II. Enforcement of and Exemptions from the Antitrust Laws A. Enforcement Public Enforcement Private Enforcement B. Exemptions III. The Sherman Act of 1890 A. Section 1: Combinations and Restraints of Trade Combination, Contract, or Conspiracy Restraints of Trade Horizontal Restraints Williamson Oil Co. v. Philip Morris, USA Vertical Restraints Leegin Creative Leather Products, Inc. v. PSKS, Inc., dba Kay’s Kloset, Kay’s Shoes Continental TV, Inc. v. GTE Sylvania B. Section 2: Monopolies Monopolization Relevant Product and Geographic Markets A. Newcal Industries, Inc. v. Ikon Office Solutions Overwhelming Power in the Market Intent to Monopolize United States v. Microsoft Corporation Attempt to Monopolize IV. The Clayton Act of 1914 A. Section 2: Price Discrimination The Meeting-the-Competition Defense B. Section 3: Tying Arrangements and Exclusive-Dealing Contracts C. Section 7: Mergers and Acquisitions Reasons for Increase in Mergers Criteria for Determining the Legality of Mergers under Section 7 Relevant Product and Geographic Markets Probable Impact on Competition Types of Mergers Defenses to Section 7 Complaints Enforcement Merger Guidelines Premerger Notification Remedies D. Section 8: Interlocking Directorates V. Other Antitrust Statutes A. Federal Trade Commission Act of 1914 California Dental Association v. Federal Trade Commission B. Bank Merger Act of 1966 VI. Global Dimensions of Antitrust Statues A. Transnational Reach of U. S. Antitrust Legislation B. Global Dimensions of U. S. Antitrust Laws C. Enforcement VII. Summary Discussion Questions for Chapter Twenty-Four 1. Explain why someone might think this statement is true: It matters whether antitrust regulators prefer the Chicago School or the Harvard School views on antitrust policy. This statement is true because those who adhere to the Chicago School prefer much less government regulation than those who prefer the Harvard School. The Harvard School is concerned about having many buyers and sellers in the economy, is worried about concentration of power, prefers local control of business, and wants efficiency of markets. Harvard School followers would apply antitrust law rigidly, and impose criminal sanctions on people who violate antitrust law. Chicago School followers want to maximize consumer welfare. They would decriminalize antitrust law, and would prefer limited government regulation of markets. 2. Explain how trusts relate to antitrust law. The abuse of trust relationships led to the development of antitrust law. Trusts are originally business arrangements in which owners of stocks in several companies place their securities in the hands of trustees, who control and manage the companies. Trusts are not illegal. However, in the late 1800’s, trusts were used by a few companies to buy up or drive out many small companies in a single industry. Because of this behavior, Congress decided to pass antitrust legislation. 3. Explain why someone might think this statement is true: Some of the goals of antitrust law are in conflict. Antitrust law strives to: (1) preserve small businesses; (2) prevent concentration of political and economic power in the hands of a few sellers in each industry; (3) preserve local control of business; and (4) promote the maximization of consumer welfare. One example of a clash is goals 1 and 4. Those who adhere to the Harvard School prefer goal 1, whereas Chicago School followers favor goal 4. Some people believe small businesses are inefficient. Large firms can make cheaper goods, and this benefits consumers. 4. Explain relationships between Section 1 and Section 2 of the Sherman Act. Both share the same penalties, but they focus on different violations. Section 1 governs illegal contracts, combinations, or conspiracies in restraint of trade, whereas Section 2 governs monopolizing, attempts to monopolize, or conspiracies to monopolize. Both sections state that these offenses are felonies, punishable by fines up to $10 million per corporation and up to $350,000 per individual. A person may be imprisoned up to three years, fined, or both. 5. Evaluate this statement: Private lawsuits are not allowed in antitrust cases. This statement is flawed. Individuals or businesses are allowed to bring private action suits against businesses they think are violating antitrust laws. Individuals can also bring class action suits. State attorneys general can also bring actions on behalf of citizens. 6. How does the concept of privity relate to material in this chapter? This would be a good final exam question because it requires students to remember material from a prior chapter. In this chapter, the textbook explains that the U.S. Supreme Court requires plaintiffs in private antitrust actions to actually be purchasers of the product. Ask students, “How is this different from our standards in product liability cases?” 7. What reasons underlie certain exemptions from antitrust statutes? People gain exemptions from antitrust statutes if they can lobby Congress effectively. Also, they will be exempt if another law regulates them. Finally, we try to protect government actors through the “state action doctrine” and by recognizing the difficulties in suing cities and towns. 8. Explain relationships between horizontal and vertical restraints. Horizontal restraints seem more offensive to courts. In vertical restraint cases, courts seem to be moving toward a rule-of-reason standard. Ask students, “Which kind of restraints interfere more with free market competition? Explain.” 9. Explain relationships between tying agreements and monopolies. Section 1 of the Sherman Act regulates tying agreements, whereas Section 2 of the Sherman Act regulates monopolies. Tying agreements are restraints of trade where the seller permits a buyer to purchase a product or service only if the buyer also agrees to purchase a second product or service. A monopoly occurs when in an economic market situation a single business has the power to fix the price of goods or services. Both situations give a business the kind of power we cannot tolerate if we want to protect competitive markets. 10. Evaluate this statement: Cases that focus on conspiracies to monopolize are more common than cases that focus on attempts to monopolize. This statement is flawed because although people fail at monopolizing (so one can sue them for attempting to monopolize), very few cases are filed under the conspiracy to monopolize theory. When a plaintiff wants to show a combination or conspiracy, it must show an agreement. The case is usually filed under Section 1 rather than Section 2 of the Sherman Act. 11. Evaluate this statement: In price discrimination cases, the Clayton Act governs both tangible goods and services and other intangible goods. This statement is flawed because in price discrimination cases, the Clayton Act governs only tangible goods such as oranges or bananas. It does not regulate services or other intangibles. 12. Explain relationships between primary, secondary, and tertiary line injuries. All are forms of price discrimination, but they vary according to who the parties to the price discrimination are. Different people are victims in each kind of price discrimination. • A primary line injury refers to a price discrimination situation in which a seller attempts to put a local competitive firm out of business by lowering its price only in the region where the local firm sells its products. • A secondary line injury occurs when a seller offers a discriminatory price to one buyer, and not to another buyer. • A tertiary line injury occurs when a discriminatory price is passed along from a secondary line party to a favored party at the next level of distribution. 13. Evaluate this statement: Mergers were a fad in the 1980’s. They are now on the decline. This statement is flawed. The mergers and acquisitions scene is still hot and growing, according to the text. Some of the activity lacks ’80s pizzazz, but the activity is still strong. Mergers are still happening because some companies have undervalued assets, some companies want to spin parts of their companies off, some companies want to diversify, some are striving for tax credits for research and development, some companies want economies of scale, and the philosophy that “bigness” is not “bad”. 14. How would the Harvard and Chicago schools respond to current trends in the field of mergers and acquisitions? The Chicago school followers believe bigness is not bad, and that the government should not try to regulate mergers and acquisitions. Followers of the Harvard school think bigness does create problems, and that it should be regulated so that the economy does not end up with some companies that enjoy large concentrations of market power. 15. Explain relationships between horizontal and vertical mergers. The two kinds of mergers differ according to where the acquired company is in the distribution system. • Horizontal mergers usually involve the acquisition of one firm by another when both firms are at the same level in the distribution system. • Vertical mergers involve the acquisition of one firm by another at different levels in the distribution system. 16. Explain relationships between vertical and conglomerate mergers. Vertical mergers involve the acquisition of one firm by another at different levels in the distribution system. Conglomerate mergers involve the acquisition by one company of a firm that produces products or services that are not directly related to the acquiring firm. One relationship is that conglomerate mergers are more likely to help a company diversify than vertical mergers. 17. Evaluate this statement: Defendants have few defenses in Section 7 cases. This statement is inadequate because defendants have several defenses in Section 7 cases. One is that the merger does not have a substantial effect on interstate commerce. Another is that the merger does not have the probability of substantially lessening competition or tending to create a monopoly. A third defense is that one of the companies to the merger is failing. A final defense is that the merger is solely for investment purposes. 18. Evaluate this statement: Private individuals and corporations rarely bring antitrust actions because it is too costly. This statement is flawed. Private actions represent by far the largest number of present-day antitrust cases. Approximately 90 percent of all antitrust claims were brought by private-party plaintiffs. Moreover, when a small company, sues a large company, for antitrust violations, victory has the double advantage of enhancing its cash flow and showing bond-rating agencies and investors that it is a viable entity able to take on a big company. 19. Explain how the Federal Trade Commission Act (FTCA) of 1914 relates to the Sherman and Clayton Acts. The FTCA prohibits unfair methods of competition. It is easier to prove a violation of the FTCA than either the Sherman or Clayton Act. The degree of proof required under the FTCA is less than under the other two acts. Answers to Critical Thinking about the Law Questions, Case Summaries, Answers to Review Questions, Review Problems, and Case Problems Suggested Answers to Critical Thinking about the Law Questions 1. Microsoft wants to be free of governmental intervention because it wants to gain market share and power. The government wants to regulate Microsoft so the company cannot use its power to the detriment of competitors and customers. Ask students to follow the case and add to the reasons that have been listed. 2. The statement is flawed because it assumes a relatively competitive market. If Microsoft operated in a market with many suppliers of homogeneous goods, it would be easy for consumers to vote with their dollars. However, the more market power Microsoft acquires, the less likely it is consumers will have many choices. 3. One does not know how the consumer might benefit from having more choices. It is possible several smaller companies have developed Web browsers that do a better job of meeting consumers’ needs. One will never know if Microsoft is allowed to decide for the consumer. So, one fact one needs to know about the World Wide Web industry is what Web browsers are available and how they compare to the Internet Explorer. Case Summary—Williamson Oil Co. v. Philip Morris, USA In the 1990s, four companies controlled the cigarette industry—Philip Morris (PM), R.J. Reynolds (RJR), Brown & Williamson (B&W), and Lorillard (the manufacturers). PM and Lorillard were the premium makers and the other two controlled the discount brands. The discount brands were making a great profit, but that was not guaranteed to continue. PM, seeing the trend, cut their prices by $0.40. The other’s followed suit. However, the discount makers refused to keep their prices too low, so they raised them to the rates of the other companies. The others followed suit. Several hundred wholesalers sued, claiming price fixing. The Courts were satisfied that the companies did not communicate to intentionally defraud the consumer, rather the price hikes were a market phenomenon seen when only a few large companies control the market. Suggested Answers to Critical Thinking about the Law Questions 1. There would have had to be communication between the companies to raise the prices. Also, the prices would have had to change at the same time, rather than in response to changes the other companies made in order to stay competitive. 2. The issue is communication of some kind. There must be some agreement to keep the prices at a certain level for there to be price fixing. Otherwise, the companies are just responding to the actions of the other. The response is in good faith, meaning that there was not prior knowledge and the prices happen to be the same because that is what the market dictates. Case Summary—Leegin Creative Leather Products, Inc. v. PSKS, Inc., dba Kay’s Kloset, Kay’s Shoes Leegin refused to sell its goods to stores that did not sell the products at the suggested prices. PSKS filed suit, alleging that Leegin violated antitrust laws by entering into vertical agreements to set prices. Leegin argued no agreements occurred, it was only a company policy. However, PSKS won the jury trial. On appeal, the Court ruled in favor of Leegin, citing that its policy was not an agreement that unfairly benefited them over all other distributors. Case Summary—Continental TV, Inc. v. GTE Sylvania This landmark case considers vertical territorial and customer restrictions. The U.S. Supreme Court changed the standard for judging such restrictions from per se to a rule of reason. GTE Sylvania had terminated a franchise agreement with Continental and sued for money owed. Continental accused Sylvania of violating the Sherman Act. The U.S. Supreme Court ruled in favor of Sylvania and returned to the rule of reason that governed vertical restrictions prior to Schwinn. Suggested Answers to Critical Thinking about the Law Questions 1. The main issue raised in this case is: Did GTE Sylvania attempt to vertically restrict the number of Sylvania retailers and was this illegal under the Sherman Act? When Continental applied for a franchise it was denied. The plaintiff claimed that this was a breach of the Sherman Act. The court found that GTE violated the Sherman Act only if this restriction led to diminished competition and promoted inefficiency. 2. The reason stated by the Court for its conclusion is that whether the per se rule stated in United States v. Schwinn & Co. should be expanded to include nonsale transactions or abandoned in favor of a return to the rule of reason. The court found no persuasive support for expanding the rule. In sum, it concluded that the appropriate decision is to return to the rule of reason that governed vertical restrictions prior to Schwinn. The court affirmed in favor of Plaintiff. Case Summary—Newcal Industries, Inc. v. Ikon Office Solutions In this case, Newcal Industries sued Ikon Office Solutions for violating the Sherman Act’s antitrust laws. The appellant court reversed the trial court’s decision and found in favor of Newcal. Newcal was able to establish a “relevant market” and show that Ikon had a contractually-created monopoly over services provided under original Ikon contracts. Therefore, Ikon is violating the Sherman Act. Case Summary—United States v. Microsoft Corporation Here, the court decides whether Microsoft has achieved a monopoly through innovation, patents, and business acumen, or whether it has attained a monopoly by conduct whose foreseeable consequence is the reinforcement of a monopoly position. The latter would show intent to monopolize. Here, after a lengthy analysis, the court concludes (1) that Microsoft possesses monopoly power, (2) that Microsoft maintained its power through anticompetitive means. The court remanded the case to consider remedies. The appellate court is more sympathetic to Microsoft than the district court, and, in its final words, discourages the district court from enacting the structural remedy of divestiture. Case Summary—California Dental Association v. Federal Trade Commission In this case, the U.S. Supreme Court considers whether the California Dental Association violated Section 5 of the Federal Trade Commission Act when it enacted restrictions on advertising for dental services. Here, the court ruled for the defendants, and remanded the case to consider the extent to which the restrictions were designed to benefit customers. Suggested Answers to Critical Thinking about the Law Questions 1. Justice Souter asserts that (1) it is difficult for dental customers to get information and (2) individual patients have a hard time determining the quality of this kind of professional service. He also assumes that patients irrationally attach themselves to particular professionals. 2. Students may make assertions that support unrestricted advertising. First, they may assert that unrestricted advertising allows customers to get quality information. Second, they may assert that patients are generally good at judging the quality of dental services. Third, they may assert that dental patients have a long history of showing their ability to switch from one dentist to another if they are dissatisfied with the quality of the services provided. Answers to Review Questions 24-1. The Department of Justice and the Federal Trade Commission in the public sector are primarily responsible for enforcement. For instance, the Antitrust Division of the Justice Department exclusively enforces the Sherman Act and has concurrent jurisdiction with the FTC to enforce the Clayton Act. However, for serious violations of the Sherman Act, the Justice Department may bring a criminal action. 24-2. Activities exempt under the U.S. antitrust laws include regulated industries, labor union activities, intrastate activities, agricultural activities, and baseball, activities that fall under the “state action” doctrine, activities of cities, towns, and villages, and export activities. These exemptions are based on federally enacted statutes or case law of the courts. When exemptions are granted by statute, they are largely the result of successful lobbying of Congress by an industry. 24-3. Horizontal restraints take place between competitors at the same level of the marketing structure, and are per se illegal. Vertical restraints are restraints agreed to between individuals or corporations at different levels of the manufacturing and distribution process. Courts are moving in the direction of judging such restraints by a rule-of-reason standard. 24-4. Conglomerate mergers involve the acquisition by one company of a firm that produces products or services that are not directly related to the acquiring firm. 24-5. Merger guidelines are not laws. Instead, they serve an advisory function. In them, the Justice Department puts the business community on notice about what the department views as Section 7 violations, and when it is most likely to bring an enforcement action. Answers to Review Problems 24-6. The circumstances in this case do not fit the price-fixing scheme between the competing companies violating the Sherman Antitrust Act. This is because it can be considered to be a single entity, which made pricing decisions where the oil companies had participated in the role of cooperative investors. 24-7. In this case the rule-of-reason standard was used and whether Topco’s behavior increases or decreases competition was considered. If Topco is correct in its assertion that it is trying to compete with large chains, their behavior is legal. If these can be established then Topco can win the case. 24-8. The key in this case will be the probable impact of the particular merger on competition in the relevant product and geographic markets. Here, it is possible that Falstaff will be able to use its power in the New England area to drive competitors out of that market. If there is a good chance Falstaff has “deep pocket” enough to eliminate competitions in New England, the Clinton Administration’s regulators will be concerned. 24-9. In order to win the suit the government would have to prove that Dentsply International, Inc. was illegally monopolizing the market and maintained this power knowingly. The relevant market in question here includes laboratories and dealers. The nearest competitor of Dentsply International, Inc. directly sells its products to laboratories. As far as monopoly is concerned Dentsply International, Inc. owned 30 percent or more of a particular market is prima facie illegal. Therefore, the Justice Department has a good chance of winning because they could make their prima facie case. 24-10. Ford will definitely have to divest itself of Autolite. It doesn’t appear that the government can require them to stop manufacturing spark plugs for ten years, or that it must purchase 50 percent of its requirements from Autolite for five years. This remedy seems harsh. If this is an acceptable remedy, we need more facts to justify this remedy. Answers to Case Problems 24-11. The case was remanded with instructions to grant the government’s injunction. The company was found to be able to manipulate prices at will and could influence distributors because they controlled the market as a monopoly. 24-12. Yes, this conduct was in violation of the Sherman Act. In this case, the plaintiff had to prove that they incurred sufficient losses owing to the pricing per se violation. 24-13. In order to win the case, Purex would have to prove that they had sustained damages. However, the Court found that there was no antitrust violation that took place and denied any damages to be paid to them. 24-14. The court found that it would be difficult to ascertain the amount of damages sustained by Edmonds. For this reason, the Court found a permanent injunction to be the best course of action in this case. 24-15. Oracle did not violate the Clayton Act because the plaintiffs could not prove that there would be a lack of competition as a result of the merger. Part of this is because they failed to prove that the market is only in the United States. In other words, there may be international companies that would have a hand in competition for the market. Thinking Critically About Relevant Legal Issues 1. The author is very concerned about fair play and theoretical capitalism. He believed in pure competition where companies are free from the shadows of large conglomerates. 2. The second-to-last paragraph is a little ambiguous. The author makes it seem as though it is easy for companies to move their base of operation. In fact, the process takes many years and is very costly. Businesses want to save money in the long run. 3. The opposition would argue that this is capitalism in action. Congress and the Courts should stay out because businesses are making record profits and selling goods to consumers at very low prices. One could also argue that they are providing jobs the people in the Third World who would not have one otherwise. Chapter 25 Laws of Debtor–Creditor Relations and Consumer Protection Introduction Chapter Twenty-Five addresses these questions: • What are the dimensions of Debtor–Creditor Relations? • What are the provisions of the federal Bankruptcy Code and the incorporation of the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005? • How has consumer law evolved? • Which specific federal laws govern trade practices and consumer–business relationships? • What federal laws focus on consumer credit arrangements and business debt-collection practices? • What is the Dodd-Frank Act and what are the laws related to consumer protection? • What are the different state consumer legislations? • What are the global dimensions of consumer protection laws? Chapter Twenty-Five is significant because the post-transaction business-consumer relationship can sometimes generate anger and litigation. Business managers and customers must know their rights and responsibilities under state, federal, and local law. This knowledge would eliminate friction and litigation between parties in consumer transactions. Achieving Teaching Excellence The Importance of the Campus Atmosphere The final Teaching Excellence section of this Instructor’s Manual looks at a different aspect of teaching and critical thinking. This Instructor’s Manual has asked instructors to take a fresh look at their behavior in class, and their students’ behavior in class. Additionally, these sections have explained one of the many reasons this textbook is important. It provides an important resource. Most textbooks do not encourage critical thinking, even when they say they do. Instead, most encourage lower-order rather than higher-order thinking skills. This textbook is the only one in the legal environment of business area that is true to its marketing promises. The textbook does much more than present facts students are supposed to absorb. It is designed to promote critical thinking skills, and if instructors have used the book to promote critical thinking, they are much farther along than most faculty members in achieving Teaching Excellence. It is sure that instructors have inferred by now that “teaching excellence” means promoting higher-order thinking skills in the classroom. Instructors are encouraging their students to evaluate, which is the primary goal of critical thinking. An instructor’s own efforts are important, but sometimes as instructors they need to change things around to make sure they are doing their best work with and for the students. This final section of the Instructor’s Manual asks instructors to look at the atmosphere on the campus. Does the campus encourage the growth of critical thinking skills? In an article entitled “Preconditions for Encouraging Critical Thinking on the Campus,” M. Neil Browne considers both factors and provides useful guidance for instructors who want to promote critical thinking. Browne makes important points about the campus atmosphere. He indicates that two aspects of a campus are particularly significant in encouraging the growth of critical thinking. Browne first explains that “a campus that has critical thinking instruction as a high priority must integrate its efforts across the curriculum.” If only one instructor uses a critical thinking approach, it will be a challenge for the instructor to get his or her students to internalize the behavior as much as he or she wants. Browne writes that “[w]hen multiple courses reinforce critical thinking behavior, students learn to associate that behavior with what educated people are expected to do.” Instructors do not want their students to leave their course thinking that their course was what Browne refers to as “an educational outlier.” Another aspect of the campus atmosphere that is important is the campus perspective on research. If instructors teach at a campus that places a high priority on research, it will be difficult to promote critical thinking skills in students. Browne writes that “[f]aculty energy is limited. Critical thinking instruction requires unusual amounts of preparation and evaluation.” Browne reminds instructors that administrators who emphasize the instructor’s roles as researchers encourage faculty members to “take the easy way out in their teaching.” The more the college or university expects instructors to publish, the more likely instructors are to lecture, post limited office hours, and avoid their students. Now, the question arises as to what instructors can do if their campus does not provide the kind of environment that urges them to achieve Teaching Excellence. If jobs for faculty members were plentiful, instructors could all look for the campus environment most consistent with their priorities? Unfortunately, most instructors have to create the kind of atmosphere they want in their present environment. Instructors should start talking to colleagues about the importance of promoting critical thinking across the curriculum. Explain to those who evaluate instructors work the clash between research productivity and teaching excellence. Browne ends his article with an important reminder, “The autonomy, tolerance, humility, and creativity potentially stimulated by critical thinking skills and attitudes can be encouraged by the conscious, systematic attempts of teachers.” Continue trying to achieve Teaching Excellence! References • M. Neil Browne, “Preconditions for Encouraging Critical Thinking on the Campus,” THE INTERNATIONAL JOURNAL OF SOCIAL EDUCATION, 18 (1987). Chapter Overview, Topic Outline, and Discussion Questions Chapter Overview This chapter describes debtor–creditor relationships; the Bankruptcy Act of 2005, which amends the federal Bankruptcy Code; and the evolution of consumer law through legislation and case law. It then examines major federal legislation governing such trade practices as advertising, labeling, and the issuance of warranties on products. Federal laws pertaining to the credit arrangements entered into by consumers and the debt-collection practices of businesses are discussed, as are state laws governing consumer transactions. The chapter ends with an examination of the global dimensions of consumer protection laws. This chapter presents information that students need to know as consumers and managers. Undergraduate students are interested in some of the material that is new to them. Many of them are for the first time getting credit cards and car loans. They are interested in knowing their rights and responsibilities. MBA students are familiar with much of the material in the chapter, but some of the information is especially important to them at this point in their lives. Many of them are purchasing houses for the first time, so they too are interested in knowing their rights and responsibilities. Several MBA students work in the financial industry, so they already know much of the material in the chapter. Still, it is good for them to see the material from a legal perspective, and they are particularly interested in the kinds of fact situations that make consumers sue. After the topic outline, the discussion questions encourage the instructors and their students to work on material from throughout the chapter. Topic Outline I. Debtor–Creditor Relations A. Rights of and Remedies for Creditors Liens Mortgage Foreclosure Suretyship and Guaranty Contracts B. Rights and Remedies for Debtors Exemptions to Attachments II. The Federal Bankruptcy Code and the Incorporation of the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 A. History and Background Provisions B. Bankruptcy Management and Proceedings Courts Bankruptcy Petition Bankruptcy Schedules Creditors’ Meeting Bankruptcy Trustee Automatic Stay Discharge Bankruptcy Estate Estate Exemptions State Exemption Fraudulent Transfers C. Chapter 7 Discharge of Debts In re Savage v. United State Bankruptcy Statutory Distribution of Property D. Chapter 13 E. Chapter 11 Individuals Filing under Chapter 11 Reorganization Small Business Bankruptcy F. Chapter 12 Chapter 12 Discharge G. The New Bankruptcy Law – 2011 III. The Evolution of Consumer Law A. Economics IV. Federal Regulation of Business Trade Practices and Consumer–Business Relationships A. The Federal Trade Commission: Functions, Structure, and Enforcement Powers Functions Structure and Enforcement Powers B. Deceptive and Unfair Advertising Deceptive Advertising Federal Trade Commission v. Verity International, Ltd. Federal Trade Commission v. QT, Inc. Unfair Advertising Private-Party Suits and Deceptive Advertising The FTC and Deceptive Labeling and Packaging C. Consumer Legislation Franchising Relationships Consumer Warranties Full or Limited Warranties Remedies Telemarketing Legislation V. Federal Laws Regulating Consumer Credit and Business Debt-Collection Practices A. Truth-in-Lending Act Goals Scope Provisions General Disclosure Finance Charges Annual Percentage Rate Right to Cancel Open- and Closed-End Credit Transactions Credit Advertising Remedies Household Credit Services, Inc. v. Pfenning B. Credit Card Accountability, Responsibility and Disclosure Act of 2009 Rates Fees Disclosure and Notice Billing Practices C. The Electronic Fund Transfer Act Goals Provisions Remedies D. A Plastic Society E. The Fair Credit Reporting Act Goals Provisions Safeco Insurance Co. v. Burr Remedies F. Identity Theft and Credit Ratings G. Equal Credit Opportunity Act Goals Provisions Remedies H. The Fair Credit Billing Act Goals Provisions Remedies I. The Fair Debt Collection Practices Act Goals Provisions Miller v. McCalla, Raymer Padrick and Clark, LLC Remedies VI. Dodd-Frank Act and Consumer Protection A. Credit and Debit Cards B. Consumer Loans C. Credit Scores D. Residential Mortgages VII. State Consumer Legislation A. Uniform Consumer Credit Code B. Unfair and Deceptive Practices Statutes C. Arbitration of Disputes VIII. Global Dimensions of Consumer Protection Laws IX. Summary Discussion Questions for Chapter Twenty-Five 1. Explain how the ideas of laissez-faire and caveat emptor are related. Laissez-faire economic philosophy presents a revolt against government regulation. This philosophy was popular in the eighteenth and nineteenth centuries. The doctrine of caveat emptor is consistent with laissez-faire philosophy. Caveat emptor means “let the consumer beware.” In other words, it is the consumers’ responsibility to protect themselves, not the government’s responsibility. 2. Evaluate this statement: The federal government has developed an efficient, coordinated plan in the area of consumer protection laws and regulations. This statement is flawed. The book is a reminder that consumer and business relationships at the federal level are governed by an array of federal agencies. These agencies often duplicate one another’s efforts and have no centralization or coordination of authority. 3. Explain relationships between deception and puffery. The most important relationship is that deception is illegal, whereas puffery is not. Puffery is an expression of opinion in a sales talk given by the seller in order to make the product more attractive. Deception in describing a product can be either express or implied. For instance, when an advertiser makes a certain quality claim based upon what “studies show,” it must possess reasonable substantiation of its claim. 4. Evaluate this statement: The FTC requires manufacturers and sellers of consumer products to give express warranties. The FTC does not require manufacturers and sellers of consumer products to give express warranties. However, if they choose to give express warranties, the Magnuson-Moss Warranty Act of 1975 places limits on what the warranties can and cannot promise. The purpose of the law is to prevent confusing and misleading information from being passed on to consumers by requiring that all conditions of a warranty be clearly and conspicuously disclosed for any product sold in interstate commerce and costing more than five dollars. 5. Explain relationships between full and limited warranties. A full warranty is a written protection for buyers that guarantees free repair of a defective product. If the product cannot be fixed the consumer must be given a choice of a refund of a replacement free of charge. In a limited warranty, the warrantor limits the scope of the warranty in some way. One relationship is that the full warranty is a more attractive sales feature to consumers than a limited warranty. 6. Explain relationships between the Truth-in-Lending Act and the Equal Credit Opportunity Act. Both laws are subparts of the Consumer Credit Protection Act, but they strive to achieve different objectives. The Truth-in-Lending Act seeks to require disclosure by creditors of all terms of a credit arrangement before an agreement is entered into with a consumer-debtor. The Equal Credit Opportunity Act strives to eliminate all forms of discrimination in granting credit, including discrimination based upon race, sex, color, religion, national origin, marital status, and receipt of public assistance. 7. Explain relationships between the Fair Credit Billing Act and the Fair Debt Collection Practices Act. Both these laws are subparts of the Consumer Credit Protection Act, but they have different purposes. The Fair Credit Billing Act aims to eliminate inaccurate and unfair billing practices, and to limit the liability of consumer creditors for the unauthorized use of their credit cards. The Fair Debt Collection Practices Act prevents harassment of a creditor of a consumer-debtor at his or her place of work or home. 8. Evaluate this statement: Consumers need credit card insurance in case their credit cards are stolen. This statement is flawed. The Electronic Fund Transfer Act, which amended the TILA, protects consumers in this situation. The liability of the holder of a credit card is limited to fifty dollars in the event someone steals and uses the card in an unauthorized manner. 9. Explain relationships between Chapters 7, 11, and 13 of the Bankruptcy Reform Act. All three are forms of bankruptcy. They differ in terms of what happens to the debts, and what happens to the person or business that went bankrupt. Under Chapter 7 (liquidation), the consumer-debtor sells his assets and the proceeds are distributed to creditors. All debts are discharged for a six-year period except taxes, child support and alimony, and credit obtained under material false pretenses. Under Chapter 13 (the wage earner’s plan), a portion of the consumer-debtor’s earnings is paid into the court for distribution to creditors over three years or, with court approval, five years. Chapter 11 allows businesses and individuals to reorganize and function while it arranges for the discharge of its debts. 10. Evaluate this statement: Federal preemption precludes states from regulating in the area of consumer protection. This statement is flawed. States also regulate in the area of consumer protection. For instance, all states have statutes that protect consumers against unfair and deceptive practices. Other common laws include “lemon laws” for used cars, and laws that provide “cooling-off” periods when they’ve purchased something from a door-to-door salesperson. Answers to Critical Thinking about the Law Questions, Case Summaries, Answers to Review Questions, Review Problems, and Case Problems Suggested Answers to Critical Thinking about the Law 1. Ethically, Woodcock should have raised the issue that his payments could not be differed as he was not a degree student. However, the mistake of issuing this student loan was on the part of the issuer. In this case the ethical norm that needs to be taken into consideration is justice where an individual can possess anything that someone else is ready to grant them. 2. The ethical norm that is closely attached to the theme of personal responsibility is security. This is because it would be the ethical norm that would fulfill a person’s order of business. Case Summary—In re. Savage v. United State Bankruptcy This case considers the concept of “undue hardship” in the context of an individual who wants to discharge student loans. A court had discharged all but $3,120 of a total student loan debt of $32,248.45. Here, the appellate court reversed the decision of the lower court, finding that the individual did not demonstrate that her current level of income and future prospects warranted discharge of her loans. The court thought she could work more at her current job or get a part-time job. The court also considered that the individual chose a private school for her son. Suggested Answers to Critical Thinking about the Law Questions 1. The legal rule is: To prove undue hardship … a debtor must show that her necessary and reasonable expenses leave her with too little to afford repayment. Additionally, she has to show that her prospects for increasing her income in the future are too limited to afford her sufficient resources to repay the student loans and provide herself and her dependents with a minimal (but fair) standard of living. 2. The case considers several ambiguous words and phrase, e.g., “undue hardship,” “satisfactory reason,” “necessary,” and “reasonable.” In this case, the court found that in the presence of the public school system sending a child to a private school was an undue expense. For this reason, this amount had to be paid by the plaintiff. Case Summary—Federal Trade Commission v. Verity International, Ltd. The Federal Trade Commission (FTC) accused Verity International and Automatic Communications of deceptive practices under Section 5 of the FTCA. Verity and Automatic Communications were deceptively charging pornography viewers using phone rather than credit card charges. The appellant court found that the companies acted in a misleading manner, consumers acted reasonably, and that the practice of the companies was material. Therefore, the court agreed with the trial court by ruling in favor of the FTC, although the court found the monetary judgment excessive. Case Summary—Federal Trade Commission v. QT, Inc. This case is about the deceptive advertising used by QY, Inc. QT falsely advertised that their bracelets would offer immediate pain relief. Both the trial and appellant courts found QT guilty of false advertising and ordered that the company stop making these promotional claims and pay $16 million into a fund for their customers. Suggested Answers to Critical Thinking about the Law Questions 1. QT might argue that individuals’ testimonies prove that the bracelets had worked and that although their advertisements exaggerated the effects of the bracelets, what they had said had not been disproved. 2. Judge Easterbrook is suggesting that anyone can make a claim but just because a man says he keeps the elephants off the streets by snapping his fingers does not mean it is true. Reliable proof is needed before someone, especially a company, can make an allegation like QT did. Case Summary—Household Credit Services, Inc. v. Pfenning This case considers whether an “over-limit fee” is a finance charge that should have been reported under the TILA. Here, the U.S. Supreme Court decides that the over-limit fee is a penalty for violating the credit agreement, and the penalty is not covered by the TILA. Case Summary—Safeco Insurance Co. v. Burr This case determined that Safeco Insurance and GEICO General Insurance were not guilty of breaking the laws of the Fair Credit Reporting Act. Although Safeco and GEICO issued insurance policies to applicants without telling them that the companies had obtained credit reports on the applicants, the Court found that the companies were not acting in reckless disregard of the act. Suggested Answers to Critical Thinking about the Law Questions 1. The Court found that GEICO and Safeco would have recklessly been disregarding the law if they had not informed the applicants of their credit reports and had charged them more for insurance. Because GEICO and Safeco offered the same initial rates to their applicants, regardless of the applicants’ credit ratings, the companies were not acting recklessly. 2. If GEICO or Safeco had charged their applicants a higher initial rate because of the credit score, they would have violated a statute of the Fair Credit Reporting Act. Case Summary—Miller v. McCalla, Raymer Padrick and Clark, LLC Miller sued McCalla for violating the FDCPA by failing to state “the amount of debt” in the dunning letter sent. Miller was successful in getting the case remanded to the trial court. The dunning letter listed the unpaid principal balance on the debt, which was only part of the debt. Lesson learned: Construct dunning letters carefully! Answers to Review Questions 25-1. In the creditor–debtor context garnishment refers to an order of the court granted to a creditor to seize wages or bank accounts of a debtor. This can be either a postjudgment or a prejudgment remedy, although the latter requires a hearing. Both federal and state laws limit the amount of money that a debtor’s take-home pay may be garnished for. 25-2. The Bankruptcy Act of 2005 changed the Federal Bankruptcy Code with an eye toward reducing bankruptcy filings. The new law changes eligibility for filing, and which debts can be discharged. The new law makes the debtor more responsible. If a person wants to discharge debts, they must prove an inability to pay the debts as they are due and demonstrate a good-faith attempt to resolve a financial crisis without a court’s help. 25-3. The FTC is most concerned about deceptive advertising concerning prices, product quality and quantity, and testimonials to products by well-known sports, entertainment, and business figures. 25-4. A contract of suretyship allows a third person to pay the debt of another (debtor) that is owed to a creditor, in the event the debtor does not pay. The suretyship creates an express contract with the creditor, under which the surety is primarily liable. 25-5. A consumer credit reporting agency must disclose the following: notice to the consumer whenever he or she has been adversely affected by an adverse credit report from a consumer reporting agency. The agency must also disclose to banks if they have made any errors in terms of reporting. Most of the other provisions protect consumers in specific ways, but they do not require “disclosure”. For instance, consumers are allowed to include a written report in their file to explain their side of a dispute if they disagree with what is in their file. 25-6. The FTC can issue injunctions. Also, individuals can pursue actions for both actual and punitive damages. Answers to Review Problems 25-7. a. Burke can file a voluntary bankruptcy petition under Chapter 12. However, under bankruptcy exemptions she would be able to retain her farm and would not have to liquidate her assets to repay her debt. b. In case, Burke does not file for voluntary bankruptcy and if she has 12 or more creditors, the petition must be signed by a minimum of 3. Also, an involuntary petition must set forth a statement that the debtor is not paying its debts as they become due. 25-8. In this case, Montoro can file for Chapter 7 bankruptcy and he has to turn all assets over to a trustee. The trustee sells the nonexempt assets and distributes the proceeds to creditors. The remaining debts are discharged. 25-9. The court affirmed the ruling that the bankruptcy discharge was void it was not in compliance with the ECMC. Also, they failed to comply with the Bankruptcy Code. 25-10. The appeals court found that the bankruptcy court had erred in its decision and affirmed the BAP’s decision to reverse and remand the case in order to apply the appropriate legal standards. The court would need to look at whether Nys was unable to make the payments even if a substantial part of her pay was used toward loan repayment. Therefore, the bankruptcy court would have to determine the merits of the case and take the correct legal standards and apply for the claim. 25-11. No. Investigative Reports must let Millstone present his side of the story. He should be allowed to write for his file an explanation that includes his denial that he is a hippie, drug user, and political dissident. Plus, if Investigative Reports’ files include incorrect information they must correct their files and tell people they gave incorrect information to of their mistakes. Answers to Case Problems 25-12. Yes, filing a lawsuit in state court can be considered as “initial communication.” Deadlines have been set for filing suits and respond to them in order to follow a structured framework. However, the deadlines set by the FDCPA differ. For this reason more importance is given to recovering the debt rather than meeting these deadlines. 25-13. Goulet was not able to discharge his loans. The mere facts that his income was low was an insufficient reason to discharge his debt. 25-14. The company’s arguments were rejected by the lower court and it stated that it could not engage in any debt collection activities. They had argued that the writer of a back check could not be considered to be consumers under the FDCPA. The company was ordered to pay any debt owed and were found liable to pay over 10 million dollars as restitution. The appeals court affirmed the decision made by the lower court. 25-15. CrossCheck, Inc. won the case as it did not violate the FDCPA. The court ruled that CrossCheck, Inc. was not acting as a “creditor” attempting to collect dishonored checks given to its merchant customers. 25-16. The defendants did violate the FCRA. The court held that conducting bank searches for third parties by repeatedly using credit reports for the purpose of developing additional financial information about search targets violated the FCRA. It was also against the law to make false representations about how the reports would be used. Using deception or trickery to obtain even more information from financial institutions was also illegal. Thinking Critically about Relevant Legal Issues 1. The author downplays freedom (for companies to act without restriction from FTC regulations) and individual responsibility (for each family to decide whether to turn off the television). 2. The relevant rule of law would highlight the extent to which companies are allowed to engage in manipulative or deceptive advertising. 3. Ads mislead children. Children are harmed psychologically when they end up disappointed that advertised products do not make them happy. Disappointments lead to cynicism. 4. The opposing argument would focus on the lack of evidence that children are so easily fooled, so easily disappointed, and so quick to become cynical. Solution Manual for The Legal Environment of Business: A Critical Thinking Approach Nancy K. Kubasek, Bartley A. Brennan, M. Neil Browne 9780133546422, 9780134074030