This Document Contains Chapters 41 to 43 Chapter 41 CONSUMER PROTECTION ANSWERS TO QUESTIONS AND CASE PROBLEMS 1. The Federal Trade Commission (FTC) brings a deceptive trade practice action against Beneficial Finance Company based on Beneficial’s use of its “instant tax refund” slogan. The FTC argues that Beneficial’s advertising a tax refund loan or instant tax refund is deceptive in that the loan is not in any way connected with a tax refund but is merely Beneficial’s everyday loan based on the applicant’s creditworthiness. Is this an unfair or deceptive trade practice? Explain. Answer: Unfair and Deceptive Trade Practices: Standards. Yes, decision for the FTC. This problem is based upon Beneficial Corp. v. FTC, 542 F.2d 611 (3rd Cir. 1976), cert. denied, 430 U.S. 983 (1977). The court had little difficulty in finding the slogan ("instant tax refund") deceptive. 2. Barnes borrows $10,000 from Linda for one year, agreeing to pay Linda $2,000 in interest on the loan and to repay the loan in twelve monthly installments of $1,000. The contract which Linda provides and Barnes signs specifies that the annual percentage rate is 20 percent. Does this contract violate the Federal Consumer Credit Protection Act? Why? Answer: Consumer Credit. Yes, judgment for Barnes. The true APR is approximately 40%, since Barnes only has, on average, the use of $5,000 for the life of the loan. Barnes must start paying off the loan immediately and is therefore paying on a diminishing loan value and not the full use of the $10,000 for one year. 3. A consumer entered into an agreement with Rent-It Corporation for the rental of a television set at a charge of $17 per week. The agreement also provides that if the renter chooses to rent the set for seventy-eight consecutive weeks, title will be transferred. The consumer now contends that the agreement is really a sales agreement, not a lease, and therefore is a credit sale subject to the Truth-in-Lending Act. Explain whether the consumer is correct. Answer: Disclosure Requirements. The agreement does not constitute a "credit sale" within the meaning of the Truth in Lending Act. Under the contract the consumer was merely obligated to rent the TV for one week; not until the rent was equal to the value of the rented television. By contrast, a purchaser under a conditional sales contract is obligated to pay the full purchase price. 4. Central Adjustment Bureau allegedly threatened Consumer with a lawsuit, service at his office, and attachment and sale of his property in order to collect a debt, although it did not intend to carry out the threat and did not have the authority to commence litigation. On some notices sent to Consumer, Central failed to disclose that it was attempting to collect a debt. In addition, Consumer contends that Central sent notices demanding payment that were purportedly from attorneys but were written, signed, and sent by Central. Has Central violated the Fair Debt Collection Act? Explain. Answer: Creditors' Remedies. If the allegations can be proven, Central would be in violation of the Fair Debt Collection Act. The FDCPA was enacted in order to eliminate abusive, deceptive and unfair practices in the collection of consumer debts by debt collection agencies. 5. The Giant Development Company undertakes a massive real estate venture to sell 9,000 one-acre unimproved lots in Utah. The company advertises the project nationally. Arrington, a resident of New York, learns of the opportunity and requests information about the project. The company provides Arrington with a small advertising brochure that contains no information about the developer and the land. The brochure consists of vague descriptions of the joys of homeownership and nothing else. Arrington purchases a lot. Two weeks after entering into the agreement, Arrington wishes to rescind the contract. Will Arrington prevail? Answer: Consumer Right of Rescission. Yes. The Interstate Land Sales Full Disclosure Act, which applies to the sale or lease of 100 or more lots of unimproved land as part of a common promotional plan, requires that the developer file a detailed statement of record with the Department of Housing and Urban Development and provide each prospective purchaser or lessee with a condensed version of the statement. If such a property report has not been presented to the purchaser in evidence of the purchase, as is the case in this problem, the purchaser may revoke the contract for a period of two years from the date of entering into the contract. Giant's advertising brochure, which was devoid of information, would not satisfy the informational requirements of the report which must be furnished to all prospective purchasers. 6. Jane Jones, a married woman, applies for a credit card from Exxon but is refused credit. Jane is bewildered as to why she was turned down. What are her legal rights in this situation? Answer: Consumer Credit: Access to the Market. Under the Equal Credit Opportunity Act, Jane Jones is entitled to be notified of specific reasons for the denial of her credit. Moreover, if the denial is based upon her sex she could successfully maintain a cause of action under said act. 7. On a beautiful Saturday in October, Francie decides to take the twenty-mile ride from her home in New Jersey into New York City to do some shopping. Francie finds that Brown’s Retail Sales, Inc., has a terrific sale on televisions and decides to surprise her husband with a new HDTV. She purchases the set from Brown’s on her VISA card for $1450. When the set is delivered, Francie discovers that it does not work. Brown’s refuses to repair or replace it or to credit Francie’s account. Francie therefore refuses to pay VISA for the television. VISA brings a suit against Francie. Will VISA prevail? Why? Answer: Consumer Credit/Disclosure Requirements. No, VISA will not prevail. Francie, under the Fair Credit Billing Act, will maintain her defenses against her credit card issuer, VISA, since she has made a good faith attempt to settle her dispute with the seller and the sale involves more than $50. Although Francie's billing address (New Jersey) is not within the same state as the seller's place of business (New York), her residence is within 100 miles of the seller's place of business. Consequently, Francie's defense of breach of contract can be successfully asserted against the plaintiff–VISA. 8. Frank finds Thomas’s wallet, which contains many credit cards and Thomas’s identification. By using Thomas’s identification and VISA card, Frank goes on a shopping spree and runs up $5,000 in charges. Thomas does not discover that he has lost his wallet until the following day, when he promptly notifies his VISA bank. How much can VISA collect from Thomas? Answer: Consumer Credit Card Fraud. $50. The FCCPA limits the card holder's liability for unauthorized use of a credit card to $50 for purchases made prior to Thomas's notification of the loss of the card to VISA. 9. Robert applies to Northern National Bank for a loan. Before granting the loan, Northern requests that Callis Credit Agency provide it with a credit report on Robert. Callis reports that three years previously, Robert had embezzled money from his employer. Based on this report, Northern rejects Robert’s loan application. (a) Robert demands to know why the loan was rejected, but Northern refuses to divulge the information, arguing that it is privileged. Is Robert entitled to the information? (b) Assume that Robert obtains the information and alleges that it is inaccurate. What recourse does Robert have? Answer: Fair Reportage. (a) Yes. Under the Fair Credit Reporting Act, Robert has the right to obtain information regarding the nature and substance of all information in the consumer reporting agency's files, the source of the information, and all recipients of such information. (b) Robert may notify Callis of this disagreement. Callis must then reinvestigate the matter and if it finds the information to be inaccurate it must promptly delete the information. If it confirms the information the consumer, if he still disputes the information, will be permitted to have a brief statement setting forth the nature of the dispute entered into the report. 10. Colgate-Palmolive Co. produced a television advertisement that dramatically demonstrated the effectiveness of its Rapid Shave shaving cream. The ad purported to show the shaving cream being used to shave sandpaper. But because actual sandpaper appeared on television to be regular colored paper, Colgate substituted a sheet of Plexiglas with sand sprinkled on it. The FTC brought an action against Colgate, claiming that Colgate’s ad was deceptive. Colgate defended on the ground that the consumer was merely being shown a representation of the actual test. Explain whether Colgate has engaged in an unfair or deceptive trade practice. Answer: The Federal Trade Commission: Standards. Yes, judgment for FTC. The advertisement was deceptive because it did not appropriately represent an actual test of the shaving cream. Under the traditional deceptions standard the ad had the tendency or capacity to deceive since it was a material misrepresentation that would tend to mislead the members of the public who were potential purchasers of shaving cream. The advertisement purported to show the test, but in fact was not. If evaluated by the current deception standard the advertisement would also be found to be deceptive. It would mislead a consumer acting reasonably under the circumstances who would assume that actually shaving with the product would be done as fast and efficiently as the ad represented. FTC v.Colgate-Palmolive, Co. 380 U.S. 374 11. Several manufacturers introduced into the American market a product known as all-terrain vehicles (ATVs). ATVs are motorized bikes that sit on three or four low-pressure balloon tires and are meant to be driven off paved roads. Almost immediately, the Consumer Product Safety Commission began receiving reports of deaths and serious injuries. As the number of injuries and deaths increased, the CPSC began investigating ATV hazards. According to CPSC staff, children under the age of sixteen accounted for roughly half the deaths and injuries associated with this product. What type of rule, if any, may the CPSC issue for ATVs? Answer: Consumer Product Safety Commission. Normally, the CPSC has the authority to: (1) work with consumers and industry to promote voluntary standards for product safety, (2) set and enforce mandatory standards, (3) ban unsafe products when a safety standard would not adequately protect the public, (4) order recalls of hazardous products, (5) provide information to help consumers select and properly use safe products, and (6) work with State and local governments to promote consumer safety. However, the agency does not have jurisdiction over all consumer goods. Motor vehicles are exempt from CPSC coverage, and therefore, no rule could be issued. 12. Sears formulated a plan to increase sales of its top-of-the-line Lady Kenmore brand dishwasher. Sears’s plan sought to change the Lady Kenmore’s image without reengineering or making any mechanical improvements in the dishwasher itself. To accomplish this, Sears undertook a four-year, $8 million advertising campaign that claimed that the Lady Kenmore completely eliminated the need to prerinse and prescrape dishes. As a result of this campaign, sales rose by more than 300 percent. The “no scraping, no prerinsing” claim was not true, however; and Sears had no reasonable basis for asserting the claim. In addition, the owner’s manual that customers received after they purchased the dishwasher contradicted the claim. After a thorough investigation, the Federal Trade Commission filed a complaint against Sears, alleging that the advertisements were false and misleading. The final FTC order required Sears to stop making the “no scraping, no prerinsing” claim. The order also prevented Sears from (1) making any “performance claims” for “major home appliances” without first possessing a reasonable basis consisting of substantiating tests or other evidence; (2) misrepresenting any test, survey, or demonstration regarding “major home appliances”; and (3) making any advertising statements not consistent with statements in postpurchase materials supplied to purchasers of “major home appliances.” Sears contends the order is too broad, because it covers appliances other than dishwashers and includes “performance claims” as well. Explain whether Sears is correct. Answer: Multiple Product Order. Judgment for the FTC. The Ninth Circuit Court of Appeals enforced the order. The court began its analysis by noting that the FTC has wide latitude for judgment and that the courts would not interfere except where the remedy had no reasonable relation to the unlawful practices found to exist. A judgment regarding "reasonable relation" in multi-product order cases "depends upon the specific circumstances of the case." The facts of the present case indicated to the court that the petitioner had acted with a blatant and utter disregard for the law, the result of an advertising campaign which was well planned and highly financed. Consequently, sufficient cause exists for concern regarding further, additional violations. In addition, as the court noted, that the prevention of "transfers" of unfair practices to other product lines was a fundamental goal of the FTC's remedial work and that the danger of such transfers was particularly likely for a national brand such as Sears which sells a variety of home appliances. The appellate court concluded by holding that the multi-product order is reasonably related to the petitioner's conduct, that a multi-product order is appropriate, and that the inclusion of the "performance claims" provision in that order is supported by the record before us and does not render the order overbroad. Sears, Roebuck and Co. v. F.T.C., 676 F.2d 385 (9th Cir. 1982). 13. Onondaga Bureau of Medical Economics (OBME), a collection agency for physicians, sent the plaintiff, Seabrook, a letter demanding payment for a $198 physicians’ bill. In addition to demanding payment, the letter stated that the bureau’s client could commence against Seabrook a legal action that could result in a garnishment of his wages. Does OBME’s letter violate the Fair Debt Collection Practices Act in that it (a) does not give Seabrook the required notice or (b) threatened legal action against him? Answer: Wage Assignments and Garnishment. The District Court held in favor of Seabrook. It noted that the letter in threatening garnishment of wages violated the Act in that it did not accurately reflect New York State garnishment law at the time it was sent. Moreover, the letter violated the disclosure provisions of the Act by failing to include language to the effect that any information obtained would be used for purposes of debt collection. This was true even though the letter did not request any information from Seabrook. Lastly, the OBME could not rely on any bona fide error defense since it did not present any evidence that it maintained proper procedures to avoid the errors complained of. Seabrook v. Onandage Bureau of Medical Economics, Inc. 705 F.Supp 81(1989). 14. William Thompson was denied credit based on an inaccurate credit report compiled by the San Antonio Retail Merchant’s Association. The Association confused Thompson’s credit history with that of another William Thompson and failed to use social security numbers to distinguish the two men. The second Mr. Thompson had a poor credit history. Thompson made numerous attempts to have the Association correct its mistake, but the error was never corrected. Has the Association violated the Fair Credit Reporting Act? Explain. Answer: Fair Reportage: Fair Credit Reporting Act. Yes, judgment for Thompson. The Fair Credit Reporting Act, 15 U.S.C. 1681e(b), provides: “When a consumer reporting agency prepares a consumer report, it shall follow reasonable procedures to assure maximum possible accuracy of information concerning the individual about whom the report relates.” The Association breached its duty of accurate reporting by failing to use adequate procedures to distinguish consumers, in this case the failure to use social security numbers in addition to names for identification purposes. The Association also failed to correct its error in a timely fashion. Thompson v. San Antonio Merchant’s Assoc., 682 F.2d 509 (5th Cir. 1982). 15. Thompson Medical Company manufactures and sells Aspercreme, a topical analgesic. Aspercreme is a pain reliever that contains no aspirin. Thompson’s advertisements strongly suggest that Aspercreme is related to aspirin, however, by claiming that it provides “the strong relief of aspirin right where you hurt.” Is Thompson’s advertisement for Aspercreme false and misleading? Explain. Answer: Misleading Advertisement. Yes, it is misleading. Judgment for the Federal Trade Commission. Actual deception is not required for an advertisement to be misleading. An advertisement is considered deceptive if it is reasonably capable of misleading the public, regardless of its truth or falsity. Aspercreme’s name and its advertisements reasonably suggest that the product contains aspirin and are likely to mislead the public. Thompson Medical Co., Inc. v. Federal Trade Commission, 791 F.2d 189 (D.C. Cir. 1986). 16. Mary Smith bought a car from Doug Chapman under an installment sales contract. Smith carried the insurance on the car, as required by the contract. Shortly after Smith purchased the car, it was wrecked in an accident. Smith’s insurance company paid Chapman the installments still owed on the car, as well as Smith’s equity in the car. Smith requested a new car from Chapman under an installment plan the same as the one under which she had purchased the first car. Chapman refused, claiming that the contract for the first car allowed him to retain the equity amount as security interest and that Smith understood this as a term of the contract. The provision relating to the security interest appeared on the back of the contract, although the Truth-in-Lending Act required it to be on the front side. The front side had a notice referring to provisions on the back side. Explain whether Chapman’s contract violates the Truth-in-Lending Act. Answer: Truth-in-Lending Act. Yes, it does. Judgment for Smith. A customer does not have to be deceived to maintain an action for violation of the Truth-in-Lending Act. The purpose of the Act is to prevent the use of illegal contracts that are not ordinarily discovered. The Act was designed not merely to compensate borrowers but to punish lenders. Under the Act, lenders are required to disclose conspicuously all terms of credit in a meaningful sequence. Chapman’s contract put the interest rate and the security interest on the back page. Chapman also failed to disclose delinquency charges and the listing of sales tax as an “original fee” in the itemized charges. The terms of a sales agreement must be written and organized so that a reasonable person will have notice of his rights and duties. Chapman’s contract did not meet these standards. Smith v. Chapman, 614 F.2d 978 (5th Cir. 1980). 17. The Federal Trade Commission (FTC) ordered Warner-Lambert to cease and desist from advertising that its product, Listerine antiseptic mouthwash, prevents, cures, or alleviates the common cold and sore throats. The order further required Warner-Lambert to disclose in future advertisements that “[c]ontrary to prior advertising, Listerine will not help prevent colds or sore throats or lessen their severity.” Warner-Lambert contended that even if its past advertising claims were false, the corrective advertising portion of the order exceeded the FTC’s statutory power. The FTC claimed that corrective advertising was necessary in light of Warner-Lambert’s 100 years of false claims and the resulting persistence of erroneous consumer beliefs. Explain whether the FTC is correct. Answer: FTC: Corrective Advertising. Judgment for the FTC. Congress intended for the FTC to have broad remedial powers in order to protect the public from deceptive trade practices. Corrective advertising represents an appropriate remedy in this case because of Warner-Lambert’s long history of deceptive advertising, the success of the advertising campaign to create a false image in the public’s mind, and the fact that this false perception would continue if not corrected. Warner-Lambert, Co. v. FTC, 562 F.2d 749. 18. Lenvil Miller owed $2,501.61 to the Star Bank of Cincinnati. Star Bank referred collection of Miller’s account to Payco-General American Credits, Inc. (Payco), a debt collection agency. Payco sent Miller a collection form. Across the top of the form was the caption, “DEMAND FOR PAYMENT,” in large, red, boldface type. The middle of the page stated “THIS IS A DEMAND FOR IMMEDIATE FULL PAYMENT OF YOUR DEBT,” also in large, red, boldface type. That statement was followed in bold by “YOUR SERIOUSLY PAST DUE ACCOUNT HAS BEEN GIVEN TO US FOR IMMEDIATE ACTION. YOU HAVE HAD AMPLE TIME TO PAY YOUR DEBT, BUT YOU HAVE NOT. IF THERE IS A VALID REASON, PHONE US AT [***] TODAY. IF NOT, PAY US—NOW.” The word “NOW” covered the bottom third of the form. At the very bottom in the smallest type to appear on the form was the statement, “NOTICE: SEE REVERSE SIDE FOR IMPORTANT INFORMATION.” The notice was printed in white against a red background. On the reverse side were four paragraphs in gray ink. The last three paragraphs contained the validation notice required by the Fair Debt Collection Practices Act (FDCPA) to inform the consumer how to obtain verification of the debt. Miller sued Payco on the ground that the validation notice did not comply with the FDCPA. Miller argued that even though the validation notice contained all the necessary information, it violated the FDCPA because it contradicted other parts of the collection letter, was overshadowed by the demands for payment, and was not effectively conveyed to the consumer. Discuss whether Payco has violated the FDCPA. Answer: Creditors' Remedies. The FDCPA requires a debt collector to send a consumer, either in its initial communication or within five days of its initial communication, a written notice containing: 1) the debt amount; 2) the name of the current creditor; 3) a statement that if the consumer disputes the debt in writing within thirty days, the collector will send verification of the debt to the consumer; 4) a statement that if the consumer does not dispute the debt within thirty days, the collector will assume the debt to be valid; 5) a statement that the collector will send the name of the original creditor, upon written request within thirty days. If the consumer, in writing, disputes the debt or requests the name of the original creditor, then the collector must halt all collection efforts until it mails verification of the debt or the creditor’s name to the consumer. The debt verification provisions are intended to protect the consumers’ legal rights and should not be contradicted or overshadowed by other messages in the notice. In this case, Payco’s notice clearly overshadowed and contradicted some paragraphs in the verification notice. Miller v. Payco-General American Credits, Inc. 943 F2d 482. 19. Greg Henson sold his Chevrolet Camaro Z-28 to his brother, Jeff Henson. To purchase the car, Jeff secured a loan with Cosco Federal Credit Union (Cosco). Soon thereafter, the car was stolen and Jeff stopped making payments on his loan from Cosco. At the time, Cosco was unsure whether Greg retained an interest in the car so Cosco sued both Jeff and Greg for possession of the car. The trial court rendered a default judgment against Jeff and ruled that Greg had no longer any interest in the car. The court further entered a deficiency judgment against Jeff in the amount of $4,076. However, the clerk erroneously noted in the judgment docket that the money judgment had been rendered against Greg as well as against Jeff. However, the official record of judgments and orders correctly reflected that only Jeff was affected by the money judgment. Two credit agencies, CSC Credit Services (CSC) and Trans Union Corporation (Trans Union), relied on the state court judgment docket and indicated in Greg’s credit report that he owed the money judgment. Greg and his wife, Mary Henson, allege that they then “contacted Trans [Union] twice, in writing, to correct this horrible injustice.” When Trans Union did not respond, the Hensons brought an action alleging violations of the Federal Credit Reporting Act (FCRA). Explain whether the Hensons should prevail. Answer: Fair Credit Reporting Act. Under FCRA, a consumer reporting agency is required to follow “reasonable procedures to assure maximum possible accuracy” of the information contained in a consumer’s credit report. A credit reporting agency is not liable under the FCRA if it followed “reasonable procedures to assure maximum possible accuracy,” but nonetheless reported inaccurate information in the consumer’s credit report. First, the information reported by CSC and Trans Union was inaccurate. Contrary to CSC and Trans Union’s contention that the Judgment Docket conclusively shows that a money judgment was entered against Greg Henson, it is the physical placing of the judgment into the “Record of Judgments and Orders” that constitutes the official entry of judgment. The official records conclusively establish that no money judgment was rendered against Greg. Although the information they reported was inaccurate, CSC and Trans Union are not liable under the FCRA if they followed “reasonable procedures to assure maximum possible accuracy” of the information reported. It may be said that the Judgment Docket is a presumptively reliable source and therefore it is reasonable to rely upon it as an initial source of information. Thus, as a matter of law, a credit reporting agency is not liable under the FCRA for reporting inaccurate information obtained from a court’s Judgment Docket, absent prior notice from the consumer that the information may be inaccurate. Finally, the Hensons’ allegation that they contacted Trans Union in an attempt to remedy the situation implicates Trans Union’s duty to reinvestigate. A credit reporting agency that has been notified of potentially inaccurate information in a consumer’s credit report is in a very different position than one who has no such notice. A credit reporting agency may initially rely on public court documents, because to require more may be unduly burdensome in the normal case. However, such exclusive reliance may not be justified once the credit reporting agency receives notice that the consumer disputes information contained in his credit report. The reasonableness of the defendant’s conduct must be resolved by the trial court on remand. Henson v. CSC Credit, 29 F.3d 280. 20. Pantron I Corporation and Hal Z. Lederman market a product known as the Helsinki Formula. This product supposedly arrests hair loss and stimulates hair regrowth in baldness sufferers. The formula consists of a conditioner and a shampoo, and it sells at a list price of $49.95 for a three-month supply. The ingredients that allegedly cause the advertised effects are polysorbate 60 and polysorbate 80. Pantron offers a full money-back guarantee for those who are not satisfied with the product. The FTC challenged both Pantron’s claims that the formula arrested hair loss and promoted growth of new hair as unfair and deceptive trade practices. The FTC presented a variety of evidence that tended to show that the Helsinki Formula had no effectiveness other than its placebo effect (achieving results due solely to belief that the product will work). The FTC introduced expert testimony of a dermatologist and two other experts who denied there was any scientific evidence that the Helsinki Formula would be in any way useful in treating hair loss. Finally, the FTC introduced evidence of two studies that had determined that polysorbate-based products were ineffective in stopping hair loss and promoting regrowth. In response, Pantron introduced evidence that users of the Helsinki Formula were satisfied that it was effective. It offered testimony of eighteen users who had experienced hair regrowth or a reduction in hair loss after using the formula. It also introduced evidence of a “consumer satisfaction survey” it had conducted. Pantron also introduced evidence that more than half of its orders come from repeat purchasers, that it had received very few written complaints, and that very few of Pantron’s customers (less than 3 percent) had redeemed the money-back guarantee. Pantron finally introduced several clinical studies of its own, none performed in the United States or under U.S. standards for scientific studies. The evidence from these studies did show effectiveness, but the studies were not random, blind-reviewed studies, and thus did not take into account the placebo effect. Discuss. Answer: Federal Trade Commission – Standards. Sections 5(a) of the Federal Trade Commission Act, declares unlawful “unfair or deceptive acts or practices in or affecting commerce” and empowers the Commission to prevent such acts or practices. Section 12 of the Act is specifically directed to false advertising. That section prohibits the dissemination of “any false advertisement” in order to induce the purchase of “food, drugs, devices, or cosmetics.” The district court concluded that the F.T.C. failed to carry its burden of proving that Pantron’s efficacy representations were false. It held that “[t]o prevail on its charge that defendant has misrepresented the efficacy of the ‘Helsinki Formula,’ the F.T.C. must prove that the product is wholly ineffective; i.e., that it does not work at all.” *** We hold that the district court erred in concluding that Pantron’s representations regarding the Helsinki Formula’s efficacy did not amount to false advertising. Although there was sufficient evidence in the record to support the district court’s finding that use of the Helsinki Formula might arrest hair loss in some of the people some of the time, the overwhelming weight of the proof at trial made clear that any effectiveness is due solely to the product’s placebo effect. ***, [W]e conclude that a claim of product effectiveness is “false” for purposes of section 12 of the Federal Trade Commission Act if evidence developed under accepted standards of scientific research demonstrates that the product has no force beyond its placebo effect. FTC v. Patron I Corp. 33 F.3d 1088. 21. Lavon Phillips became engaged to marry Sarah Grendahl and moved in with her. Sarah’s mother, Mary, became suspicious that Phillips was not telling the truth about his past, particularly about whether he was an attorney and where he had worked. She also was confused about who his ex-wives and girlfriends were and where they lived. She did some preliminary investigation herself, but she felt that she was hampered by not being able to use a computer, so she contacted Kevin Fitzgerald, a family friend who worked for McDowell, a private investigation agency. She asked Fitzgerald to do a “background check” on Phillips. Fitzgerald searched public records in Minnesota and Alabama, where Phillips had lived earlier and discovered one suit against Phillips for delinquent child support in Alabama, a suit to establish child support for two children in Minnesota, and one misdemeanor conviction for writing dishonored checks. Fitzgerald then supplied the social security information to Econ Control (a business which furnishes credit reports, Finder’s Reports, and credit scoring for credit companies and for private investigators) and asked for “Finder’s Reports” on Phillips. Fitzgerald testified that he believed that Finder’s Reports were not consumer reports and therefore they were not subject to the Federal Credit Reporting Act (FCRA). William Porter, president of Econ Control, stated that he believed a “Finder’s Report” could be obtained without authorization of the person who was the subject of the report because the Finder’s Report contained no information on credit history or creditworthiness. Econ Control than obtained a consumer report from Computer Science Corporation on Phillips and passed it onto McDowell. Fitzgerald met with Mary Grendahl and gave her the results of his investigation, including the Finder’s Report. Did this investigation violate the Fair Credit Reporting Act? Explain. Answer: Fair Reportage. Phillips must prove that there was a consumer report, that defendants used or obtained it, and that they did so without a permissible statutory purpose. He must also prove that the defendants acted with the specified level of culpability. In this case, there is no dispute that the Finder’s Report was (1) a written communication (2) by a consumer reporting agency, Computer Science Corporation. The two issues in dispute pertaining to whether the Finder’s Report is a consumer report are (3) whether it contained the sort of personal information that would bring it within the definition and (4) whether anyone “expected” the Finder’s Report or the information in it to be used for one of the purposes listed in the definition or “collected” the information in it for that purpose. Finally, although there is evidence that none of the three defendants believed their conduct to be covered by the FCRA, all three knew that such reports can only be obtained legally under certain circumstances. This can support an inference that the defendants knew their actions were impermissible and were therefore liable for their actions. Phillips v. Grendahl, United States Court of Appeals, 312 F.3d 357 (Eighth Circuit, 2002). 22. In the late 1990s, Ian Eisenberg and Chris Hebard formed Electronic Publishing Ventures, LLC (EPV) and its four subsidiaries: Cyberspace.com, LLC, Essex Enterprises, LLC, Surfnet Services, LLC, and Splashnet.net, LLC. Two offshore entities, French Dreams Investments, N.V. (collectively EFO and owned by Eisenberg) and Coto Settlement (controlled by Hebard) owned EPV in equal parts. Between January 1999 and mid-2000, EPV’s four subsidiaries mailed approximately 4.4 million solicitations offering Internet access to individuals and small businesses. The solicitations included a check, usually for $3.50, attached to a form resembling an invoice designed to be detached from the check by tearing at the perforated line. The check was addressed to the recipient and the recipient’s phone number appeared on the “re” line. The back of the check and invoice contained small-print disclosures revealing that cashing or depositing the check would constitute agreement to pay a monthly fee for Internet access, but the front of the check and the invoice contained no such disclosures. The mailing explained in small print that a monthly fee would be billed to the customer’s local phone bill after the check was cashed or deposited. At least 225,000 small businesses and individuals cashed or deposited the solicitation checks. The EPV subsidiaries used a billing aggregation service to place charges for $19.95 or $29.95 a month on the small businesses’ and individuals’ ordinary telephone bills. Internet usage records show, however, that less than 1 percent of the 225,000 individuals and businesses billed for Internet service actually logged on to the service. Eisenberg and Hebard were aware that the solicitation had misled some consumers. The companies received complaints from recipients of the solicitations, which indicated that some customers had deposited the solicitation check without realizing that they had contracted for Internet services. The Federal Trade Commission alleges that the solicitations were deceptive in violation of Section 5 of the Federal Trade Commission Act. Explain whether or not the FTC is correct. Answer: Disclosure Requirements. The FTC is correct. An act or practice is deceptive if (1) there is a representation, omission, or practice that, (2) is likely to mislead consumers acting reasonably under the circumstances, and (3) the representation, omission, or practice is material. Federal Trade Commission v. Cyberspace.com LLC, United States Court of Appeals, Ninth Circuit, 2006, 453 F.3d 1196. Section 5 of the FTCA prohibits “deceptive acts or practices in or affecting commerce.” A practice falls within this prohibition (1) if it is likely to mislead consumers acting reasonably under the circumstances (2) in a way that is material. In this case, Hebard and EFO wrongfully contend that the fine print notices they placed on the reverse side of the check, invoice, and marketing insert preclude liability under FTCA Section 5. A solicitation may be likely to mislead by virtue of the net impression it creates even though the solicitation also contains truthful disclosures. Hebard and EFO’s mailing created the deceptive impression that the $3.50 check was simply a refund or rebate rather than an offer for services. The front of the check and invoice lacked any indication that by cashing the check, the consumer was contracting to pay a monthly fee. This solicitation was likely to deceive consumers acting reasonably under the circumstances. This conclusion is bolstered by undisputed evidence indicating that Hebard and EFO’s solicitation actually deceived nearly 225,000 individuals and small businesses. Hebard and EFO billed each of these consumers for a service that less than 1 percent of them ever attempted to use. It is reasonable to infer that most of the remaining 99 percent did not realize they had contracted for Internet service when they cashed or deposited the solicitation check. Clearly, the solicitation was likely to mislead in a way that is material. A misleading impression created by a solicitation is material if it “involves information that is important to consumers and, hence, likely to affect their choice of, or conduct regarding, a product.”]] ANSWERS TO “TAKING SIDES” PROBLEMS Kevin Miller bought a house in Atlanta in 2012 and took out a mortgage. He lived in the house until 2015, when he accepted a job in Chicago; from then on, he rented the house. He received a letter demanding payment from a law firm on behalf of the mortgage company in 2017. By this time, Miller was renting the property to strangers and thus was making a business use of the property. Miller claimed that the law firm had violated the Fair Debt Collection Practices Act. The law firm replied that the letter is outside the scope of the Act because it was trying to collect a business debt rather than a consumer debt. (a) What are the arguments that the debt is a consumer debt? (b) What are the arguments that the debt is a business debt? (c) Which arguments would prevail? Explain. Answer: (a) The relevant time for deciding whether the debt is business or consumer is the time that the debt was undertaken. Here the debt was taken by a consumer and only became a rental because they had to move out of the house. The owners of the property needed protection since they were not sophisticated landlords. (b) The property at the time of the letter was used as a business property and thus should be treated as such. (c) The debt is a consumer debt. The Fair Debt Collection Practices Act regulates the debt collection tactics employed against individual borrowers on the theory that they are likely to be unsophisticated about debt collection and thus prey to unscrupulous collection methods. Collections made on loans to businesses are not subject to the Act because it is assumed that businesspeople do not need the warnings. The defendants contend that since the Act governs debt collection, the relevant time is when the attempt at collection is made. Since the house was being used for business purposes at the time of collection, the defendants claim that they were not required to state the exact total of the debt. The relevant time is when the loan is made, not when collection is attempted. It makes more sense to base the debt collector’s obligation on the character of the debt when it arose rather than when it is to be collected. The original creditor is more likely to know whether the debt was personal or commercial at its issuance. Against this, the defendants argue that the plaintiff’s interpretation creates a loophole. Suppose the plaintiff had bought the house to use as an office, and later converted it to personal use; on the plaintiff’s interpretation of the Act, the debt collector would not have to give him the statutory warnings. But this makes perfect sense. A businessman who converts a business purchase to personal use does not by virtue of that conversion lose his commercial sophistication and so acquire a need for statutory protection. Thus the Act is applicable. Miller v. McCalla, Raymer, Padrick, Cobb, Nichols, and Clark, L.L.C., United States Court of Appeals, Seventh Circuit, 2000, 214 F.3d 872. Chapter 42 EMPLOYMENT LAW ANSWERS TO QUESTIONS AND CASE PROBLEMS 1. Gooddecade manufactures and sells automobile parts throughout the eastern part of the United States. Among its full-time employees are 220 fourteen- and fifteen-year-olds. These teenagers are employed throughout the company and are paid at an hourly wage rate of $5 per hour. Discuss the legality of this arrangement. Answer: Fair Labor Standards Act. This problem raises two Fair Labor Standards Act questions: (a) minimum wage and (b) child labor. Gooddecade is paying below the minimum wage. Second, by employing individuals on a full-time basis who are less than sixteen years of age Gooddecade has likewise violated the Act. The Act prohibits the employment of anyone under fourteen years in non-farm work with certain exceptions and only permits the employment of fourteen and fifteen year olds for a limited number of hours (part-time) outside of school hours and only under special conditions. 2. Janet, a twenty-year-old woman, applied for a position driving a truck for Federal Trucking, Inc. Janet, who is 5’4” tall and weighs 135 pounds, was denied the job because the company requires that all employees be at least 5’6” tall and weigh at least 150 pounds. Federal justifies this requirement on the basis that its drivers are frequently forced to move heavy loads in making pickups and deliveries. Janet brings a cause of action. Has Federal Trucking violated the Civil Rights Act? Explain. Answer: Civil Rights Act of 1964: Discrimination. Yes. Janet would prevail under the Civil Rights Act of 1964. Height and weight tests are questionable on their face in that they disproportionately act across gender and hence the courts have placed upon employers the burden of justifying such restrictions. As stated in Griggs v. Duke Power the Civil Rights Act of 1964 prohibits "not only overt discrimination but also practices that are fair in form, but discriminatory in operation." In this situation other less arbitrary tests could be utilized, for instance Federal Trucking could have employed a strength test or could equip its truck with equipment to allow for the easier movement of heavy loads. 3. N.I.S. promoted John, a forty-two-year-old employee, to a supervisor’s position while passing over James, a fifty-eight-year-old employee. N.I.S. told James he was too old for the job and that it preferred a younger man. Discuss whether James will succeed if he brings a cause of action. Answer: Age Discrimination in Employment Act of 1967. James would succeed. The Age Discrimination in Employment Act protects individuals between the ages of forty and seventy for discrimination in hiring, firing, salaries or otherwise on the basis of age. In Moore v. Sears, F. Supp. 357 (1979) the United States district Court held that an employer violates the Age Discrimination Act if it favors a younger employee on the basis of age even if that younger employee does come within the protection of the Act; i.e., is between the ages of forty and seventy. Thus, in this problem when N.I.S. promoted forty-two-year-old John over a fifty-eight-year-old James because it preferred the younger man, N.I.S. violated the law. 4. Anthony was employed as a forklift operator for Blackburn Construction Company. While on the job, he operated the forklift in a manner that was careless and in direct violation of Blackburn’s procedural manual and, as a result, caused himself severe injury. Blackburn denies liability based on Anthony’s (a) gross negligence, (b) disobedience of the procedural manual, and (c) written waiver of liability. Can Anthony recover for his injury? Explain. Answer: Worker's Compensation. Under Worker's Compensation laws an employee who is injured on the job is entitled to compensation regardless of fault. The amounts recoverable are established by state law for each type of injury sustained. In return, in the great majority of states, the employee forfeits his rights to bring a cause of action against the employer from injuries which come within the Act. The courts only have jurisdiction to review whether the state board or commission ruling is in accordance with the Act, therefore Anthony cannot bring an action at law against Blackburn. 5. Hazelwood School District is located in Sleepy Hollow Township. It is being sued by several teachers who applied for teaching positions with the school but were rejected. The plaintiffs, who are all African-Americans, produce the following evidence: (a) 1.8 percent of the Hazelwood School District's certified teachers are African-American, whereas 15.4 percent of the certified teachers in Sleepy Hollow Township are African-American; and (b) the hiring decisions by Hazelwood School District are based solely on subjective criteria. Will the plaintiffs prevail? Explain. Answer: Civil Rights Act of 1964/National Labor Relations Act. In the case of Hazelwood School District v. United States, 433 U.S. 299, 97 S. Ct 2736, 53 L. Ed. 2d 768 (1977) the Supreme Court held that proof that 1.8% of a particular school district's teachers were black while 15.4% of the region's school teachers were black, when combined with subjective hiring practices that could have produced such a disproportionate result, is sufficient for a prima facie case of racial discrimination. In remanding the case to the U.S. Court of Appeals the Court was mindful that "When special qualifications are required to fill particular jobs comparisons to the general population rather than to the smaller group of individuals who possess the necessary qualifications may have little probative value." Thus, the court only compared minority and non-minority certified teachers. 6. T. W. E., a large manufacturer, prohibited its employees from distributing union leaflets to other employees while on the company’s property. Richard, an employee of T. W. E., disregarded the prohibition and passed out the leaflets before his work shift began. T. W. E. discharged Richard for his actions. Has T. W. E. committed an unfair labor practice? Answer: National Labor Relations Act: Unfair Labor Practice. . The National Labor Relations Act provides the right to self-organize and declares certain conduct by an employer as unfair labor practices. An employer cannot prevent an employee during non-working hours from distributing union related information, provided he did not interfere with the work of others. An employer violates Section 8(a)(1) of the National Labor Relations Act when it threatens employees with reprisals or other unfavorable consequences as a result of their union activities. Since Richard's activity occurred before his work shift began, and therefore did not interfere with his performance on the job, the T.W.E. prohibition would be deemed an unfair labor practice. Hence, T.W.E’s discharge of Richard is unlawful 7. Erwick was dismissed from her job at the C & T Steel Company because she was “an unsatisfactory employee.” At the time, Erwick was active in an effort to organize a union at C & T. Is the dismissal valid? Answer: National Labor Relations Act. Under the National Labor Relations Act, it would be considered an unfair labor practice for C&T to interfere with its employees' rights to unionize. Under the facts as stated, since Erwick was a union organizer and then dismissed, the burden of proof would fall upon C&T to demonstrate Erwick's "unsatisfactory" performance and thereby its legitimate right to terminate Erwick. 8. Johnson, president of the First National Bank of A, believes that it is appropriate to employ only female tellers. Hence, First National refuses to employ Ken Baker as a teller but does offer him a maintenance position at the same salary. Baker brings a cause of action against First National Bank. Is First National illegally discriminating based on gender? Why? Answer: Title III, Civil Rights Act of 1964. Yes, this is discrimination; decision for Baker. First National's hiring criteria based on gender is violative of the Civil Rights Act of 1964. Title VII of the Act prohibits discrimination on the basis of sex, race, color, religion, or national origin in the hiring, firing, compensating, or otherwise treating employees. First National's belief that it is only appropriate for females to work as bank tellers is not a valid defense. The three basic defenses are: (1) a bona fide seniority system; (2) a professionally developed ability test; and (3) a bona fide occupational qualification. The third test does not encompass arbitrary and personal standards of opinion. 9. Section 103 of the Federal Public Works Employment Act establishes the Minority Business Enterprise (MBE) program and requires that, absent a waiver by the Secretary of Commerce, 10 percent of all federal grants given by the Economic Development Administration be used to purchase services or supplies from businesses owned and controlled by U.S. citizens belonging to one of six minority groups: African-American, Spanish-speaking, Asian, Native American, Eskimo, and Aleut. White owners of businesses contend the act constitutes illegal reverse discrimination. Discuss. Answer: Employment Discrimination Law. The Act is Constitutional since Congress relied on its right to provide for the general welfare. Also, it could be argued that Congress had a rational basis for concluding that the prejudicial activities of primary contractors in not subcontracting to minorities had an effect on interstate commerce. The equal protection clause could also be relied upon here as a basis for breaking down barriers to minority firms. 10. Worth H. Percivil, a mechanical engineer, was employed by General Motors (GM) for twenty-six years until he was discharged. At the time his employment was terminated, Percivil was head of GM’s Mechanical Development Department. Percivil sued GM for wrongful discharge. He contends that he was discharged as a result of a conspiracy among his fellow executives to force him out of his employment because of his age, because he had legitimately complained about certain deceptive practices of GM, because he had refused to give the government false information although urged to do so by his superiors, and because he had, on the contrary, undertaken to correct certain alleged misrepresentations made to the government. General Motors claims that Percivil’s employment was terminable at the will of GM for any reason and with or without cause, provided that the discharge was not prohibited by statute. Has Percivil been wrongly discharged? Why? Answer: Employee Termination at Will. Judgment for General Motors. In the 1975 case which serves as the basis for this problem, Percival v. General Motors, 400 F. Supp. 1322, the court held that Percival’s “discharge did not involve a breach of public policy sufficient to state a cause of action for wrongful or retaliatory discharge." Simply because the discharge was unjustified does not create a cause of action unless it can be demonstrated that there existed compelling contractual, statutory, or public policy considerations. It should be noted also that the trend against the termination at will contract was a "newly emerging theory" at that time. The instructor could explore the possibility as to whether this case would be decided similarly by a court today. Percival v. General Motors, 400 F. Supp. 1322 11. Samsoc brought an action against the Sailors’ Union alleging that the Union had induced and encouraged employees of Moore Dry Dock Company to engage in a strike or concerted refusal in the course of their employment to perform services for Moore in connection with the conversion into a bulk gypsum carrier of the SS Phopho, a vessel owned by Samsoc, the object being to force Moore to cease doing business with Samsoc and thus force Samsoc to resolve its dispute with the respondent. Has an unfair labor practice been committed? Explain. Answer: Unfair Labor Practices/Secondary Activities. The activity of the union is in violation of Section 8(b) of the Labor Management Relations Act. A secondary activity is a boycott, strike, or picketing of an employer with whom a union has no labor dispute in order to persuade the employer to cease doing business with the company that is the target of the labor dispute. The strike against Moore is secondary activity that is prohibited as an unfair labor practice. In the Matter of SAILORS' UNION OF THE PACIFIC, AFL and MOORE DRY DOCK COMPANY Case No. 20-CC-55, NLRB. 12. The defendant, Berger Transfer and Storage, operated a national moving and transfer business employing approximately forty persons. In May and June, Local 705 of the International Brotherhood of Teamsters spoke with a number of Berger employees, obtaining twenty-eight cards signed in support of the union. The management of Berger, unwilling to work with the union, attempted to prevent it from representing Berger employees. The company first assigned all work to those with high seniority, in effect temporarily laying off low-seniority employees. The management then threatened to lay off permanently those with low seniority and threatened all employees with a total closedown of the plant. The management interrogated several employees about their union involvement and attempted to extract information about other employees’ activities. When the union presented the company with the signed cards and recognition agreement, Berger refused to acknowledge the union’s existence or its right to bargain on behalf of the employees. The union then called a strike, with employees picketing the Berger warehouse. During the picketing, the company threatened to terminate the picketers if they did not return to work. Later, one manager on two occasions recklessly drove a truck through the picket line, striking employees. Finally, the company contacted several of the employees and offered them the “grievance procedures and job security” the union would provide. The employees refused the offer. On June 15, the strike ended, with most of the picketers returning to work. Local 705 filed a complaint with the National Labor Relations Board, alleging that Berger had committed unfair labor practices in violation of the National Labor Relations Act. Will Local 705 succeed? Explain. Answer: N.L.R.B. N.L.R.B. order in favor of the union affirmed. The NLRB concluded that Berger had violated sections 8(a)(1), (3), and (5) of the Act. The board's findings are supported by substantial evidence in the record. Berger committed eighteen 8(a)(1) violations, which may be classified as follows: (1) questioning employees about union activities, (2) threatening employees with termination, layoff, and plant closure, (3) creating the impression of surveillance of employees, (4) promising to redress employee complaints, (5) assaulting employees, and (6) actual layoff and termination of employees. These actions were all unfair labor practices under Section 8(a)(1) in that they tended to interfere with, restrain, or coerce employees in their exercise of the right of self-organization. Berger also violated Section 8(a)(3) of the Act, which makes it an unfair labor practice to discriminate against an employee in order to discourage membership in a labor organization, where such discrimination is "in regard to hire or tenure of employment or any term or condition of employment." Berger discharged and laid off several employees and demoted another, all in reaction to union activities. Finally, Section 8(a)(5) of the Act provides that an employer who has been presented with cards showing majority employee support for the union, and who has subsequently engaged in unfair labor practices, loses any right to demand an election and must bargain with the union. Berger violated this section of the Act as well. The union had valid authorization cards from twenty-eight of forty-two employees, but Berger met its request for recognition only with flagrant, unfair labor practices. NLRB v. Berger Transfer & Storage, 678 F.2d 679. 13. City of Richmond, Virginia (the City) adopted a Minority Business Utilization Plan requiring prime contractors awarded city construction contracts to subcontract at least 30 percent of the dollar amount of each contract to one or more Minority Business Enterprises (MBEs). The plan defined an MBE to include a business from anywhere in the United States that is at least 51 percent owned and controlled by African-American, Spanish-speaking, Asian, Native American, Eskimo, or Aleut citizens. Although the plan declared that it was “remedial” in nature, it was adopted after a public hearing at which no direct evidence was presented that the City had discriminated on the basis of race in letting contracts or that its prime contractors had discriminated against minority subcontractors. The evidence introduced in support of the plan included a statistical study indicating that, although the City’s population was 50 percent African-American, less than 1 percent of its prime construction contracts had been awarded to minority businesses in recent years. Additional evidence showed that a variety of local contractors’ trade associations had virtually no MBE members. J. A. Croson Co., the sole bidder on a city contract, was denied a waiver and lost its contract because of the plan. Discuss the legality of the plan. Answer: Affirmative Action. The Court affirmed in favor of Crosen. The Court noted that the distinction made in levels of review of affirmative action programs in the Fullilove and Wygandt opinions was proper. Under Fullilove, Federal affirmative action programs are not subject to a "strict scrutiny" review since Congress was acting pursuant to its unique enforcement powers under the Fourteenth Amendment. No such ability is preserved under the Fourteenth Amendment for non-federal governments. An affirmative action program implemented by non-federal governments, being racially based, is subject to review under the strict scrutiny test. A generalized assertion that there has been past discrimination in the entire construction industry cannot justify the use of an unyielding racial quota, since it provides no guidance for the City's legislative body to determine the precise scope of the injury it seeks to remedy and would allow race-based decision-making to be essentially limitless in scope and duration. Moreover, the Plan is not narrowly tailored to remedy the effect of specific and localized prior discrimination, since it entitles a black, Hispanic, Indian or Asian from anywhere in the United States to an absolute preference over other citizens based solely on their race. Although many of the barriers to minority participation in the construction industry relied upon by the City to justify the Plan appear to be race neutral, there is no evidence that the City considered using alternative, race-neutral means to increase minority participation in City contracting. The Plan's rigid 30% quota rests upon the completely unrealistic assumption that minorities will choose to enter the construction industry in exact proportion to their representation in the local population. City of Richmond v. JA Croson, 109 S. Ct. 706. 14. Burdine, a woman, was hired by the Texas Department of Community Affairs as a clerk in the Public Service Careers (PSC) Division. The PSC provides training and employment opportunities for unskilled workers. At the time she was hired, Burdine already had several years’ experience in employment training. She was soon promoted, and later, when her supervisor resigned, she performed additional duties that usually had been assigned to the supervisor. Burdine applied for the position of supervisor, but the position remained unfilled for six months, until a male employee from another division was brought in to fill it. Burdine alleges discrimination violating Title VII of the 1964 Civil Rights Act. The defendant, Texas Department of Community Affairs, responds that nondiscriminatory evaluation criteria were used to choose the new supervisor. In order to comply with Title VII, must the Texas Department of Community Affairs hire Burdine as supervisor if she and the male candidate are equally qualified? Explain. Answer: Civil Rights Act of 1964. No, the Texas Dept. of Community Affairs is not required to hire Burdine. Title VII prohibits employment discrimination on the basis of race, color, sex, religion, or national origin. However, Title VII does not require an employer to give preferential treatment to minorities or women. The statute was not intended to diminish traditional management prerogatives. An employer still has the discretion to choose among equally qualified candidates, as long as the choice is not based upon unlawful criteria as listed in Title VII. Texas Dept. of Community Affairs v. Burdine, 450 U.S. 248, 101 S.Ct. 1089. 67 L.Ed.2d 207 (1981). 15. Wise was fired from her job at the Mead Corporation after she was involved in a fight with a co-worker. On four other unrelated occasions, fights had occurred between male co-workers. Only one of the males was fired, but this was after his second fight, in which he seriously injured another employee. There is no dispute that Wise was qualified and performed her duties adequately. Wise successfully established a prima facie case of discrimination. However, the defendant, Mead Corporation, met its burden to “articulate legitimate and nondiscriminatory reasons” for firing Wise. Can she prevail? Explain. Answer: Discrimination/Disparate Treatment. Wise may still win this case. Plaintiff must first establish a prima facie case of discrimination by showing 1) she is a member of a protected class; 2) she was qualified for the job from which she was fired; and 3) the misconduct for which she was fired was similar to that engaged in by employees outside the protected class whom the employer retained. The burden then shifts to the defendant to “articulate some legitimate, non-discriminatory reason for the employee’s discharge.” Note, however, that this is only an intermediate burden of production, for the burden of persuasion never shifts to the defendant. The defendant need not persuade the court that it was motivated by the proffered reasons. Of course, failure to meet this burden of production would cause the plaintiff to win with no further showing. If the defendant meets this burden, the plaintiff may still prevail if she proves that the articulated reasons for discharge were in fact a pretext for discrimination. Plaintiff can prove pretext by convincing the trier of fact that discrimination was a more likely motivation, or that the employer’s stated reasons are not credible. Wise v. Mead Corp., 614 F.Supp 1131 (D.C.Ga. 1985). 16. The United Steelworkers of America and Kaiser Aluminum entered into a master collective bargaining agreement covering terms and conditions of employment at fifteen Kaiser plants. The agreement contained an affirmative action plan designed to eliminate conspicuous racial imbalances in Kaiser’s then almost exclusively white craftwork forces. African-American craft-hiring goals were set for each Kaiser plant equal to the percentage of African-Americans in the respective local labor forces. To meet these goals, on-the-job training programs were established to teach unskilled production workers—African-Americans and whites—the skills necessary to become craftworkers. The plan reserved for African-American employees 50 percent of the openings in these newly created in-plant training programs. Pursuant to the national agreement, Kaiser altered its craft-hiring practice in its Gramercy, Louisiana, plant by establishing a program to train its production workers to fill craft openings. Selection of craft trainees was made on the basis of seniority. At least 50 percent of the new trainees were to be African-American until the percentage of African-American skilled craftworkers in the Gramercy plant approximated the percentage of African-Americans in the local labor force. During this affirmative action plan’s first year of operation, thirteen craft trainees (seven African-American, six white) were selected from Gramercy’s production workforce. The most senior African-American selected had less seniority than several white production workers who were denied admission to the program. Does the affirmative action plan wrongfully discriminate against white employees and therefore violate the Civil Rights Act of 1964? Justify your decision. Answer: Civil Rights Act of 1964. No, the plan did not wrongfully discriminate against white employees; judgment for United Steelworkers of America. The Civil Rights Act of 1964 was primarily intended to open employment opportunities to African-Americans in occupations that have been traditionally closed to them. It is not intended to prohibit the private sector from implementing voluntary, private affirmative action plans to accomplish this purpose. Here, the Kaiser-USWA affirmative action plan promotes the Act’s goal of providing equal employment opportunities to African-Americans without unnecessarily trammeling the interests of the white employees. It did not require the discharge of the white workers and their replacement with new African-American hirees. Nor did the plan create an absolute bar to the advancement of white employees because half of those trained in the program were white. Furthermore, the plan was a temporary measure to eliminate manifest racial imbalance. Therefore, the Kaiser-USWA affirmative action plan did not violate the Civil Rights Act. United Steelworkers of America v. Weber, 443 U.S. 193, 99 S. Ct. 2721 (1979). 17. At Whirlpool’s manufacturing plant in Ohio, overhead conveyors transported household appliance components throughout the plant. A wire mesh screen was positioned below the conveyors in order to catch falling components and debris. Maintenance employees frequently had to stand on the screens to clean them. Whirlpool began installing heavier wire because several employees had fallen partly through the old screens, and one had fallen completely through to the plant floor. At this time, the company warned workers to walk only on the frames beneath the wire but not on the wire itself. Before the heavier wire had been completely installed, a worker fell to his death through the old screen. A short time after this incident, Deemer and Cornwell, two plant employees, met with the plant safety director to discuss the mesh, to voice their concerns, and to obtain the name, address, and telephone number of the local Occupational Safety and Health Administration (OSHA) representative. The next day, the two employees refused to clean a portion of the old screen. They were then ordered to punch out for the remainder of the shift without pay and received written reprimands, which were placed in their employment files. Does Whirlpool’s actions against Deemer and Cornwell constitute discrimination in violation of the Occupational Safety and Health Act? Explain. Answer: OSHA. Yes. Judgment for the employees. The U.S. Supreme Court held that when an employee is ordered by his employer to work under conditions that the employee reasonably believes pose an imminent risk of death or serious bodily injury, and the employee has reason to believe that there is not sufficient time or opportunity to either seek effective redress from his employer or to apprise OSHA of the danger, he may refuse to expose himself to the dangerous condition, without being subjected to "subsequent discrimination" by his employer. Whirlpool v. Marshall, 445 U.S. 1. 18. John Novosel was employed by Nationwide Insurance Company for fifteen years. Novosel had been a model employee and, at the time of discharge, was a district claims manager and a candidate for the position of division claims manager. During Novosel’s fifteenth year of employment, Nationwide circulated a memorandum requesting the participation of all employees in an effort to lobby the Pennsylvania state legislature for the passage of a certain bill before the body. Novosel, who had privately indicated his disagreement with Nationwide’s political views, refused to lend his support to the lobby, and his employment with Nationwide was terminated. Novosel brought two separate claims against Nationwide, arguing, first, that his discharge for refusing to lobby the state legislature on behalf of Nationwide constituted the tort of wrongful discharge in that it was arbitrary, malicious, and contrary to public policy. Novosel also contended that Nationwide breached an implied contract guaranteeing continued employment so long as his job performance was satisfactory. What decision as to each claim? Answer: Employment at Will. Decision for Novosel—the allegation of breach of the implied contract on the part of Nationwide is a question of fact that must be decided by the fact-finder. A cause of action in tort for wrongful discharge is permitted under Pennsylvania law where the employment termination contradicts a significant and recognized public policy. Pennsylvania law does not directly address the public policy question at issue in this case, and Nationwide suggests that the only limit upon employee termination is the violation of some “statutorily recognized public policy.” Novosel’s tort action, however, is supported by the definition of a “clearly mandated public policy” as one that “strikes at the heart of a citizen’s social right, duties and responsibilities.” Clearly, society has a compelling interest in protecting an employee’s freedom of political expression. With respect to the breach of contract action, Pennsylvania law does not currently require just cause for employee discharges. Rapidly unfolding judicial developments, however, have addressed the contractual claims of non-union employees. Thus, Novosel’s allegations of breach of an implied contract on the part of Nationwide is a question of fact that should not be dismissed. Novosel v. Nationwide Insurance, 721 F.2d 894. 19. During the years prior to the passage of the Civil Rights Act of 1964, Duke Power openly discriminated against African-Americans by allowing them to work only in the labor department of the plant’s five departments. The highest paying job in the labor department paid less than the lowest paying jobs in the other four “operating” departments in which only whites were employed. In 1955, the company began requiring a high school education for initial assignment to any department except labor. However, when Duke Power stopped restricting African-Americans to the labor department in 1965, it made completion of high school a prerequisite to transfer from labor to any other department. White employees hired before the high school education requirement was adopted continued to perform satisfactorily and to achieve promotions in the “operating” departments. In 1965, the company also began requiring new employees in the departments other than labor to register satisfactory scores on two professionally prepared aptitude tests, in addition to having a high school education. In September 1965, Duke Power began to permit employees to qualify for transfer to another department from labor by passing either of the two tests, neither of which was directed or intended to measure the ability to learn to perform a particular job or category of jobs. Griggs brought suit against Duke Power, claiming that the high school education and testing requirements were discriminatory and therefore prohibited by the Civil Rights Act of 1964. Is Griggs correct? Why? Answer: Civil Rights Act. Yes, judgment for Griggs. The 1964 Civil Rights Act is meant to achieve equality of employment opportunities and to remove barriers that have operated to favor white employees over other workers. The act prohibits not only overt discrimination but also practices, procedures, or tests that are fair in form yet discriminatory in practice. The standard is business necessity. If an employment practice works to exclude African-Americans and does not relate to job performance, the practice is prohibited. In this case, even in departments that required a high school education and passing scores on the tests, employees lacking these qualifications were able to perform satisfactorily and make progress. Thus, Duke Power simply was not able to demonstrate that a high school education and scores on a general intelligence test were linked to successful job performance. Rather, the company’s requirements served covertly to discriminate and therefore were prohibited by the 1964 Civil Rights Act. Griggs v. Duke Power, 401 U.S. 424. 20. Michelle Vinson was an employee of Meritor Savings Bank for approximately four years. Beginning as a teller-trainee, she ultimately advanced to the position of assistant branch manager. Her promotions were based solely upon merit. Sidney Taylor, a vice president of the bank and manager of the branch office in which Vinson worked, was Vinson’s supervisor throughout her employment with the bank. After the bank fired Vinson for her abusive use of sick leave, she brought an action against Taylor and the bank, alleging that during her employment she had “constantly been subjected to sexual harassment” by Taylor in violation of Title VII of the Civil Rights Act of 1964. At trial, Vinson introduced evidence that Taylor repeatedly demanded sexual favors from her, fondled her in front of other employees, and forcibly raped her on a number of occasions. Taylor and the bank categorically denied Vinson’s allegations. Does the conduct constitute sexual harassment? Explain. Answer: Sexual Harassment. Judgment for Vinson affirmed. Title VII of the 1964 Civil Rights Act prohibits sexual discrimination in the workplace “against any individual with respect to his compensation, terms, conditions, or privileges of employment.” The Court of Appeals correctly held that a violation exists if sexual harassment creates a hostile or offensive working environment, even if employment benefits are not linked to sexual favors. The language of Title VII and guidelines issued by the Equal Employment Opportunity Commission in 1980 support this conclusion. In contrast, the District Court’s finding that any sexual relationship between Vinson and Taylor “was a voluntary one” cannot be supported under Title VII. Vinson’s willingness is immaterial if Taylor allegedly made unwelcome advances or if he made her comply with his advances as a condition of her continued employment. The Court of Appeals also erred, however, in holding that an employer is strictly liable for a hostile working environment created by a supervisor’s sexual advances even when the employer neither knows nor could reasonably know of the employee’s alleged misconduct. While lack of notice may not necessarily protect the employer from liability, Congress, by defining “employee” to include an “agent” of an employer, apparently intended to put limits on the acts of workers for which employers are held liable under Title VII. 21. Plaintiff, Beth Lyons, a staff attorney for the Legal Aid Society (Legal Aid) brought suit against her employer, alleging that Legal Aid violated the Americans with Disabilities Act (ADA) and the Rehabilitation Act by failing to provide her with a parking space near her office. Plaintiff worked for defendant in its lower Manhattan office. Lyon’s disability was the result of being struck and nearly killed by an automobile. For six years from the date of the accident, Lyons was on disability leave from Legal Aid; she underwent multiple reconstructive surgeries and received “constant” physical therapy. Since the accident, Lyons has been able to walk only by using walking devices, including walkers, canes, and crutches. Since returning to work Lyons has performed her job duties successfully. Nevertheless, her condition severely limits her ability to walk long distances either at one time or during the course of a day. Before returning to work, Lyons asked Legal Aid to accommodate her disability by providing her a parking space near her office and the courts in which she would practice. She stated that this would be necessary because she is unable to take public transportation from her home in New Jersey to the Legal Aid office in Manhattan because such “commuting would require her to walk distances, climb stairs, and on occasion to remain standing for extended periods of time,” thereby “overtax[ing] her limited physical capabilities.” Lyons’s physician advised Legal Aid by letter that such a parking space was “necessary to enable [Lyons] to return to work.” Legal Aid informed Lyons that it would not pay for a parking space for her. Accordingly, Lyons has spent $300 to $520 a month, representing 15 percent to 26 percent of her monthly net salary, for a parking space adjacent to her office building. Are the accommodations requested by Lyons unreasonable? Why? Answer: Americans with Disabilities Act. . As defined by the ADA, discrimination includes not making reasonable accommodations to the known physical or mental limitations of an otherwise qualified individual with a disability who is an applicant or employee, unless ... [the employer] can demonstrate that the accommodation would impose an undue hardship on the operation of the ... [employer's] business. The Rehabilitation Act, which prohibits disability-based discrimination by government agencies and other recipients of federal funds, is similar. Thus, under either the ADA or the Rehabilitation Act, a plaintiff can state a claim for discrimination based upon her employer's failure to accommodate her handicap showing (1) that the employer is subject to the statute, (2) that she is an individual with a qualifying disability, (3) that, with or without reasonable accommodation, she could perform the essential functions of the job, and (4) that the employer had notice of the plaintiff's disability. Of these four elements, the only question is whether Lyons's request that Legal Aid provide her with a parking space near work is, as a matter of law, not a request for a "reasonable" accommodation (number 3 above). Neither the ADA nor the Rehabilitation Act provides a closed-end definition of "reasonable accommodation." The ADA’s nonexclusive list of different methods of accommodation includes (A) making existing facilities used by employees readily accessible to and usable by individuals with disabilities; and (B) job restructuring or reassignment to a vacant position, acquisition or modification of equipment or devices, appropriate adjustment or modifications of examinations, training materials or policies, the provision of qualified readers or interpreters, and other similar accommodations for individuals with disabilities. The regulations promulgated under the Rehabilitation Act use virtually the same language as the ADA. Additional regulations promulgated by the EEOC under the ADA state that the employer is required to provide [m]odifications or adjustments to the work environment, or to the manner or circumstances under which the position held or desired is customarily performed, but does not require the employer to make accommodations that are "primarily for personal benefit," or to provide "any amenity or convenience that is not job-related." Legal Aid argues that Lyons's claim for financial assistance in parking her car is a demand for unwarranted preferential treatment because the accommodation is "a matter of personal convenience that she uses regularly in daily life." Although the question of whether it is reasonable to require an employer to provide parking spaces may well be susceptible to differing answers depending on the employer's location and financial resources, it is clear that Congress envisioned that employer assistance with transportation to get the employee to and from the job might be covered. An accommodation may not be considered unreasonable merely because it requires the employer "to assume more than a de minimis cost," or because it will cost the employer more overall to obtain the same level of performance from the disabled employee. Lyons v. Legal Aid, 68 F.3d 1 51. 22. The Steamship Clerks Union has approximately 124 members, 80 of whom are classified as active. Members serve as steamship clerks who, during the loading and unloading of vessels in the port of Boston, check cargo against inventory lists provided by shippers and consignees. The work is not taxing; it requires little in the way of particular skills. On October 1, the Union formally adopted the membership sponsorship policy (the MSP), which provided that any applicant for membership in the Union (other than an injured longshoreman) had to be sponsored by an existing member for his application to be considered. The record reveals, without contradiction, that (1) the Union had no African-American or Hispanic members when it adopted the MSP; (2) blacks and Hispanics constituted from 8 percent to 27 percent of the relevant labor pool in the Boston area; (3) the Union welcomed at least thirty new members over the next six years and then closed the membership rolls; (4) all “sponsored” applicants during this period and, hence, all the new members, were Caucasian; and (5) every recruit was related to (usually the son or brother of) a Union member. After conducting an investigation and instituting administrative proceedings, the EEOC brought suit, alleging that the Union had discriminated against African-Americans and Hispanics by means of the MSP. Explain whether or not the EEOC will prevail. Answer: Discrimination/Disparate Treatment. Broadly speaking, Title VII of the Civil Rights Act of 1964, outlaws discrimination based on race, color, religion, gender, or national origin. In so doing, the law forbids both "overt discrimination" in the form of disparate treatment, and more subtle forms of discrimination, known as disparate impact discrimination, arising from "the consequences of employment practices, not simply the motivation." Discrimination may result from otherwise neutral policies and practices that, when actuated in real-life settings, operate to the distinct disadvantage of certain classes of individuals. Thus, the disparate impact approach roots out "employment policies that are facially neutral in their treatment of different groups but that in fact fall more harshly on one group than another and cannot be justified by business necessity." In the disparate impact approach, the prima facie case consists of three elements: identification, impact, and causation. In this case, the district court adroitly applied the substantive law and concluded that the Union's sponsorship-based membership policy constituted disparate impact discrimination. The EEOC carried its burden of producing facts sufficient to show the three elements essential to its prima facie case. The first element-identification-requires no elaboration. The combined pool of potential black and Hispanic applicants for union membership ranged between 8% and 27% of the overall pool of potential applicants. Despite the fact that during the MSP's heyday- --the Union admitted 30 new members, no African- American or Hispanic was granted Union membership. Based on a comparison of these figures, the district court found that the EEOC adequately demonstrated a race-based disparate impact. Once the EEOC demonstrated a prima facie case of discrimination, the burden of production shifted. In the absence of any applicable statutory exemption, it became incumbent upon the Union either to mount a satisfactory empirical rebuttal or to show that the challenged practice was job-related and consistent with business necessity. The Union suggests that the MSP is job-related and consistent with business necessity because it represents an important vehicle for continuing family traditions. Most of the 30 new members, according to the Union, "joined simply because their fathers had been members and because they wanted to maintain a family tradition...." We approach the task of evaluating this rationale mindful that the meaning and scope of the "business necessity" concept are blurred at the edges. In the case at bar, however, such potential indeterminacy is of no consequence, for the Union's "family tradition" thesis falls hopelessly short of being a business necessity. EEOC v. Steamship Clerks Union, local 1066, 48 F.3d 594. 23. Johnson Controls’ implemented a policy that women who are pregnant or who are capable of bearing children would not be placed into jobs involving lead exposure. In April 1984, employees filed a class action lawsuit challenging Johnson Controls’ fetal-protection policy as sex discrimination that violated Title VII of the Civil Rights Act of 1964. Among the individual plaintiffs were Mary Craig, who had chosen to be sterilized to avoid losing her job; Elsie Nason, a fifty-year-old divorcee, who had suffered a loss in compensation when she was transferred out of a job that exposed her to lead; and Donald Penney, who had been denied a request for a leave of absence for the purpose of lowering his lead level because he intended to become a father. Discuss whether the plaintiffs have a valid cause of action. Answer: Discrimination/Disparate Treatment. Yes, judgment for the petitioners. The bias in Johnson Controls’ policy is obvious. Fertile men, but not fertile women, are given a choice as to whether they wish to risk their reproductive health for a particular job. [T]he Civil Rights Act of 1964, [citation], prohibits sex-based classifications in terms and conditions of employment, in hiring and discharging decisions, and in other employment decisions that adversely affect an employee’s status. Respondent’s fetal-protection policy explicitly discriminates against women on the basis of their sex. The policy excludes women with childbearing capacity from lead-exposed jobs and so creates a facial classification based on gender. 24. Ella Williams began working at Toyota’s automobile manufacturing plant in Georgetown, Kentucky, in August 2010. She was placed on an engine fabrication assembly line, where her duties included work with pneumatic tools. Use of these tools eventually caused pain in her hands, wrists, and arms. She sought treatment at Toyota’s in-house medical service, where she was diagnosed with bilateral carpal tunnel syndrome and bilateral tendinitis. Williams consulted a personal physician who placed her on permanent work restrictions that precluded her from lifting more than 20 pounds or from “frequently lifting or carrying of objects weighing up to 10 pounds,” engaging in “constant repetitive ... flexion or extension of [her] wrists or elbows,” performing “overhead work,” or using “vibratory or pneumatic tools.” In light of these restrictions, for the next two years Toyota assigned Williams to various modified duty jobs. Nonetheless, Williams missed some work for medical leave, and eventually filed a claim under the Kentucky Workers’ Compensation Act. The parties settled this claim, and Williams returned to work. Upon her return, Toyota placed Williams on a team in Quality Control Inspection Operations (QCIO). QCIO is responsible for four tasks: (1) “assembly paint”; (2) “paint second inspection”; (3) “shell body audit”; and (4) “ED surface repair.” Williams was initially placed on a team that performed only the first two of these tasks, and for a couple of years, she rotated on a weekly basis between them. Williams was physically capable of performing both of these jobs and that her performance was satisfactory. During the fall of 2016, Toyota announced that it wanted QCIO employees to be able to rotate through all four of the QCIO processes. Williams therefore received training for the shell body audit job, in which team members apply a highlight oil to the hood, fender, doors, rear quarter panel, and trunk of passing cars at a rate of approximately one car per minute. The highlight oil has the viscosity of salad oil, and employees spread it on cars with a sponge attached to a block of wood. After they wipe each car with the oil, the employees visually inspect it for flaws. Wiping the cars required respondent to hold her hands and arms up around shoulder height for several hours at a time. A short while after the shell body audit job was added to Williams’ rotations, she began to experience pain in her neck and shoulders. However, she could still brush her teeth, wash her face, bathe, tend her flower garden, fix breakfast, do laundry, and pick up around the house. Williams requested that Toyota accommodate her medical conditions by allowing her to return to doing only her original two jobs in QCIO, which Williams claimed she could still perform without difficulty. Toyota refused. Subsequently Williams was terminated. Williams sued Toyota for failing to provide her with a reasonable accommodation as required by the Americans with Disabilities Act (ADA). Explain whether Williams has a successful cause of action against Toyota. Answer: Disability Law. Reasonable To qualify as disabled, a claimant must *** show that the limitation on the major life activity is “substantial.” To be substantially limited in performing manual tasks, an individual must have an impairment that prevents or severely restricts the individual from doing activities that are of central importance to most people's daily lives. The impairment's impact must also be permanent or long term. The District Court noted that at the time respondent sought an accommodation from petitioner, she admitted that she was able to do the manual tasks required by her original two jobs in QCIO. In addition, according to respondent’s deposition testimony, even after her condition worsened, she could still brush her teeth, wash her face, bathe, tend her flower garden, fix breakfast, do laundry, and pick up around the house. The record also indicates that her medical conditions caused her to avoid sweeping, to quit dancing, to occasionally seek help dressing, and to reduce how often she plays with her children, gardens, and drives long distances. But these changes in her life did not amount to such severe restrictions in the activities that are of central importance to most people’s daily lives that they establish a manual-task disability as a matter of law. ANSWERS TO “TAKING SIDES” PROBLEMS Mark Hunger was the safety director at Grand Central Sanitation. On September 7, Hunger “became aware” that hazardous materials consisting of blasting caps were being deposited into garbage containers at Shu-Deb, Inc. Grand Central collected garbage from these containers and dumped it at a dump site. Hunger knew that Grand Central was not licensed to dispose of hazardous materials and believed that it would violate state and/or federal law if the company transported or disposed of hazardous materials. Hunger also became concerned about the safety of company employees from the danger of transporting blasting caps. On September 9, Hunger informed Grand Central’s owner and vice president, Gary Perin, of the information he received about the blasting caps. On September 12, Hunger, accompanied by Pennsylvania state police and agents of the Federal Bureau of Alcohol, Tobacco, and Firearms, went to search the contents of Shu-Deb’s containers. However, the garbage had already been collected, so Hunger and the police located the garbage truck that had collected the garbage and searched it. No hazardous materials were found in the truck. On October 4, Hunger was terminated because of the incident. Hunger sued Grand Central for wrongful termination. (a) What are the arguments that Hunger was wrongfully terminated? (b) What are the arguments that Hunger was legally terminated? (c) Will Hunger will prevail? Explain. Answer: (a) Hunger’s discharge was wrongful due to the public- policy exception to the doctrine of at-will employment. Hunger was taking action that was to protect the public against dangers of transporting blasting caps. It is necessary to support individuals who are acting in good faith to protect the public. (b) Hunger was not correct in his assertion and thus does not come within the public- policy exception to the doctrine of at-will employment. Hunger should not be protected to make false claims against his employer. Grand Central did not do anything improperly. (c) Wrongful Termination -- Hunger will not prevail. To state a public- policy exception to the at-will-employment doctrine, the employee must point to a clear public policy articulated in the constitution, in legislation, an administrative regulation, or a judicial decision. Furthermore, the stated mandate of public policy must be applicable directly to the employee and the employee’s actions. It is not sufficient that the employer’s actions toward the employee are unfair. In this case, the claim is made (rightly) that it is illegal to transport hazardous materials without a license. However, Hunger admitted in his complaint that no blasting caps were discovered. Thus, Grand Central did not violate the law. If Hunger had observed a deliberate violation of the law, reported it to proper authorities, and was fired, then the reasoning of a public- policy exception may have been applicable. There is no indication that this occurred here. The outcome of this case may have been different if Hunger had discovered that his employer was deliberately transporting hazardous materials after being told of the situation. That is not what occurred, regardless of Hunger’s concern with the public safety. The source of appellant’s “awareness” of the alleged illegal activities is completely unsubstantiated. Furthermore, his employer’s criminal intent is not established. At most, one of the employer’s customers allegedly was dumping illegal explosives. Hunger v. Grand Central Sanitation, Superior Court of Pennsylvania, 1996 , 447 Pa. Superior Ct. 575, 670 A.2d 173. Chapter 43 SECURITIES REGULATION ANSWERS TO QUESTIONS AND CASE PROBLEMS 1. Acme Realty, a real estate development company, is a limited partnership organized in Georgia. It is planning to develop a 200-acre parcel of land for a regional shopping center and needs to raise $1,250,000. As part of its financing, Acme plans to offer $1,250,000 worth of limited partnership interests to about 100 prospective investors in the southeastern United States. It anticipates that about forty to fifty private investors will purchase the limited partnership interests. (a) Must Acme register this offering? Why or why not? (b) If Acme must register but fails to do so, what are the legal consequences? Answer: Regulation A. (a) Acme's offering would be an offering of a security under the 1933 Act as limited partnership interests are almost always considered securities. So, Acme must register its offering of limited partnership interests unless exempt. Under these facts Acme could use Regulation A which permits an issuer to offer up to 5 million dollars of securities in any 12-month period without registering them if the issuer files notification and an offering circular with the SEC. The circular must also be provided to offerees and purchasers. It is conceivable, but unlikely, that Acme could qualify for the private placement exemption. Securities sold under this exemption are restricted securities and may be resold only by registration or in a transaction exempt from registration. General advertising or solicitation is not permitted. The issue may be purchased by an unlimited number of "accredited investors" and by no more than thirty-five other purchasers. Accredited investors include banks, insurance companies, investment companies, executive officers or directors of the issuer, savings and loan associations, registered broker-dealers, certain employee benefit plans with total assets in excess of $5 million, any person whose net worth exceeds $1 million, and any person whose income exceeded $200,000 in each of the two preceding years and who reasonably expects an income in excess of $200,000 in the current year. If the sale involves any nonaccredited investors, the issuer must, before the sale, give such purchasers specified material information about the issuer, its business, and the securities being offered. If all the purchasers are accredited investors, such disclosure is not mandatory. The issuer must reasonably believe that each purchaser who is not an accredited investor has sufficient knowledge and experience in financial and business matters to evaluate the merits and risks of the investment or has the services of a representative who possesses such knowledge and experience. The issuer must notify the SEC of sales made under the exemption and must take precautions against nonexempt, unregistered resales. It is possible but not likely that Acme could qualify for the exemption provided to limited offers not exceeding $5,000,000, if it meets all of the requirements of Rule 505: General advertising or solicitation is not permitted. The issue may be purchased by an unlimited number of "accredited" purchasers and by no more than thirty-five other purchasers. If the sale involves any non-accredited persons, they must be given prior to the sale information material to an understanding of the issuer, its business, and the securities being offered; otherwise, such information is not required. However, unlike Rule 506, the issuer is not required to reasonably believe that each non-accredited investor, alone or with his representative, has such knowledge and experience in financial matters that he is capable of evaluating the merits and risks of the investment. The issuer must take precautions against non-exempt unregistered resales and must notify the SEC of sales made pursuant to the exemption. Even less likely, although possible, is that Acme could qualify for an exemption under Section 4(6). To do so, only accredited persons may purchase not more than $5,000,000 of securities, no advertising is permitted, Acme must notify the SEC of the sale and take precautions against non-exempt, unregistered resales. (b) Acme is civilly liable under Section 12(l) to any person who purchased the security from it. Such purchasers may rescind and recover the purchase price or they may sue for damages. If Acme willfully failed to register, it is subject to criminal sanctions under Section 24. 2. Bigelow Corporation has total assets of $850,000, sales of $1,350,000, and one class of common stock with 375 shareholders and a class of preferred stock with 250 shareholders, both of which are traded over the counter. Which provisions of the Securities Exchange Act of 1934 apply to Bigelow Corporation? Answer: 1934 Act: Anti-Fraud Provision. Bigelow is subject to Section 10(b) of the 1934 Act and the anti-bribery provisions of the Foreign Corrupt Practices Act. Bigelow is not required to register under the 1934 Act because it is not listed on any national stock exchange, does not have assets in excess of $5 million and does not have a single class of equity securities with 500 or more shareholders. It is not subject to the Act's periodic reporting requirements, the short-swing profits provision, the tender offer provision, the proxy solicitation provisions and the internal control and record keeping requirements of the Foreign Corrupt Practices Act. 3. Capricorn, Inc., is planning to “go public” by offering its common stock, which previously had been owned by only three shareholders. The company intends to limit the number of purchasers to twenty-five persons residing in the state of its incorporation. All of Capricorn’s business and all of its assets are located in its state of incorporation. Based on these facts, what exemptions from registration, if any, are available to Capricorn, and what conditions would each of these available exemptions impose on the terms of the offer? Answer: Intrastate Issues. (a) Intrastate Exemption. The most likely exemption would be the intrastate exemption. Rule 147 requires that: (1) the issuer is incorporated or organized in the state in which the issuance occurs; (2) the issuer is principally doing business in that state, which means that 80% of its gross revenues must be derived from that state, 80% of its assets must be located in that state, and 80% of the net proceeds from the issue must be used in that state; (3) all of the offerees and purchasers are residents of that state; (4) during the period of sale and for nine months after the last sale, no resales to non-residents are made; and (5) precautions are taken against interstate distribution. The facts indicate that the first and second requirements have been met. If Capricorn also limits all the offerees to residents of the state of its incorporation and meets the fourth and fifth requirements, then the intrastate exemption would be available. (b) Limited Offers Not Exceeding $1 Million. Rule 504 of the SEC provides private, non-investment company issuers with an exemption from registration for small issues. The exemption requires that the aggregate offering price within twelve months does not exceed $1 million and that the issuer notifies the SEC of sales under the rule. If Capricorn meets these conditions (the dollar limitation in particular) Rule 504 would provide an exemption. (c) Regulation A. This regulation permits an issuer to offer up to $5 million of securities in any twelve-month period without registering them provided that the issuer files a notification and an offering circular with the SEC's regional office. The circular must also be provided to offerees and purchasers. The facts do not indicate how much securities are to be sold. If Capricorn plans to sell less than $5 million then Regulation A would be available. (d) Limited Offers Not Exceeding $5 Million. Rule 505 exempts from registration offerings by non-investment company issuers that do not exceed $5,000,000 over twelve months. Securities sold under this exemption are restricted securities and may be resold only by registration or in a transaction exempt from registration. General advertising or general solicitation is not permitted. The issue may be purchased by an unlimited number of "accredited" purchasers and by no more than thirty-five other purchasers. If the sale involves any non-accredited persons, such purchasers must be furnished prior to the sale with information material to an understanding of the issuer, its business, and the securities being offered; otherwise, such information is not required to be disclosed. However, unlike Rule 506, the issuer is not required to reasonably believe that each non-accredited investor, either alone or with his representative, has such knowledge and experience in financial matters that he is capable of evaluating the merits and risks of the investments. The issuer must take precautions against non-exempt unregistered resales and must notify the SEC of sales made pursuant to the exemption. Conceivably, Capricorn might be able to utilize Rule 505. (e) Private Placements. Rule 506 of the SEC establishes a non-exclusive safe harbor for limited offers and sales without regard to the dollar amount of the offering. Securities sold under this exemption are restricted securities and may be resold only by registration or in a transaction exempt from registration. General advertising or solicitation is not permitted. The issue may be purchased by an unlimited number of "accredited investors" and by no more than thirty-five other purchasers. Accredited investors include banks, insurance companies, investment companies, executive officers or directors of the issuer, savings and loan associations, registered broker-dealers, certain employee benefit plans with total assets in excess of $5 million, any person whose net worth exceeds $1 million, and any person whose income exceeded $200,000 in each of the two preceding years and who reasonably expects an income in excess of $200,000 in the current year. If the sale involves any nonaccredited investors, the issuer must, before the sale, give such purchasers specified material information about the issuer, its business, and the securities being offered. If all the purchasers are accredited investors, such disclosure is not mandatory. The issuer must reasonably believe that each purchaser who is not an accredited investor has sufficient knowledge and experience in financial and business matters to evaluate the merits and risks of the investment or has the services of a representative who possesses such knowledge and experience. The issuer must notify the SEC of sales made under the exemption and must take precautions against nonexempt, unregistered resales. The facts of this problem make it unlikely, although conceivable, that this exemption would be available to Capricorn. (f) Limited Offers Solely to Accredited Investors. Section 4(6) provides an exemption for offers and sales by an issuer made solely to accredited investors if not in excess of $5 million dollars. General advertising or general solicitation is not permitted. Like Rules 505 and 506 an unlimited number of accredited investors may purchase the issue; however, unlike these rules, no unaccredited investors may purchase at all. No information is required to be furnished to the purchasers. Securities sold under this exemption are restricted securities and may be resold only by registration or in a transaction exempt from registration. The issuer must take precautions against non-exempt, unregistered resales and must notify the SEC of sales made pursuant to the exemption. 4. The boards of directors of DuMont Corp. and Epsot, Inc., agreed to enter into a friendly merger, with DuMont Corp. to be the surviving entity. The stock of both corporations was listed on a national stock exchange. In connection with the merger, both corporations distributed to their shareholders proxy statements seeking approval of the proposed merger. The shareholders of both corporations voted to approve the merger. About three weeks after the merger was consummated, the price of DuMont stock fell from $25 to $13 as a result of the discovery that Epsot had entered into several unprofitable long-term contracts two months before the merger had been proposed. The contracts will result in substantial losses from Epsot’s operations for at least the next four years. The existence and effect of these contracts, although known to both corporations at the time of the proposed merger, were not disclosed in the proxy statements of either corporation. Can the shareholders of DuMont recover in a suit against DuMont under the 1934 Act? Explain. Answer: Proxy Solicitation. Yes, decision for the shareholders of DuMont Corp. DuMont is subject to the proxy regulations of the 1934 Act as it was listed on a national exchange. These regulations require the issuer to furnish security holders with a proxy statement describing all material facts concerning the matter being submitted to their vote–i.e., the proposed merger with Epscot Inc. Without question, several unprofitable long term contracts entered into by Epscot which will result in substantial losses for at least four years is a material fact. Omitting to disclose it renders the proxy statement false and misleading and makes the issuer liable to any person who suffers a loss caused by reliance upon the statement. 5. Farthing is a director and vice president of Garp, Inc., whose common stock is listed on the New York Stock Exchange. Farthing engaged in the following transactions in the same calendar year: on January 1, Farthing sold 500 shares at $30 per share; on January 15, she purchased 300 shares at $30 per share; on February 1, she purchased 200 shares at $45 per share; on March 1, she purchased 300 shares at $60 per share; on March 15, she sold 200 shares at $55 per share; and on April 1, she sold 100 shares at $40 per share. Howell brings suit on behalf of Garp, alleging that Farthing has violated the Securities Act of 1934. Farthing defends on the ground that she lost money on the transactions in question. Is Farthing liable? If so, under which provisions and for what amount of money? Answer: Short-Swing Profits. Decision for Howell on behalf of Garp in the amount of $6,000. Even though Farthing lost $6,000 on these transactions, because she was an insider under Section 16 (b) and all the transactions were within 6 months of each other, she is liable for any profit realized. The profit recoverable is calculated by matching the highest sale price against the lowest purchase price within six months of each other. Losses cannot be offset against profits. The 200 shares sold for $55 will be matched with 200 of the shares purchased for $30. Then, the 100 shares sold for $40 will be matched with the remaining 100 shares purchased for $30. After that, all matches result in a loss which cannot be used to offset the recovery. Accordingly– 6. Intercontinental Widgets, Inc., had applied for a patent for a new state-of-the-art widget that, if patented, would significantly increase the value of Intercontinental’s shares. On September 1, the U.S. Patent and Trademark Office notified Jackson, the attorney for Intercontinental, that the patent application had been approved. After informing Kingsley, the company’s president, of the good news, Jackson called his broker and purchased 1,000 shares of Intercontinental at $18 per share. He also told his partner, Lucas, who immediately proceeded to purchase 500 shares at $19 per share. Lucas then called his brother-in-law, Mammon, and told him the news. On September 3, Mammon bought 4,000 shares at $21 per share. On September 4, Kingsley issued a press release that accurately reported that a patent had been granted to Intercontinental. On the next day, Intercontinental’s stock soared to $38 per share. A class action suit is brought against Jackson, Lucas, Mammon, and Intercontinental for violations of Rule 10b–5. Who, if anyone, is liable? Answer: 1934 Act: Antifraud Provision. Jackson, Lucas and Mammon are all liable for violating Rule 10b-5 by trading on inside information. When any person possesses material information regarding a security, which information is non-public and that person has reason to know it is non-public, he may not buy or sell that security without first disclosing the "inside information" or waiting until the information becomes public. The affirmative duty of disclosure extends beyond executives and directors to all employees and any person who is entrusted with the information solely for corporate purposes, as Jackson was. Moreover, Jackson's tippees–Lucas and Mammon–are also liable if they knew or should have known that Jackson had breached his fiduciary duty. Jackson, Lucas and Mammon all traded before the press release was disseminated and the information was material as indicated by the sharp increase in market price of stock after the press release. It is unlikely that Intercontinental would be liable as the press release was accurate. A possible basis could be the delay in issuing the press release. 7. Nova, Inc., sought to sell a new issue of common stock. It registered the issue with the SEC but included false information in both the registration statement and the prospectus. The issue was underwritten by Omega & Sons and was sold in its entirety by Periwinkle, Rameses, and Sheffield, Inc., a securities broker-dealer. Telford, who was unaware of the falsity of this information, purchased 500 shares at $6 per share. Three months later, the falsity of the information contained in the prospectus was made public, and the price of the shares fell to $1 per share. The following week, Telford brought suit against Nova, Inc.; Omega & Sons; and Periwinkle, Rameses, and Sheffield, Inc., under the Securities Act of 1933. (a) Who, if anyone, is liable under the Act? If liable, under which provisions? (b) What defenses, if any, are available to the various defendants? Answer: 1933 Act: Liability. (a) Under Section 11, liability is imposed upon (1) the issuer; (2) all persons who signed the registration statement; (3) every person who was, or who consents to be named as being or about to become, a director or partner; (4) every accountant, engineer, appraiser, or expert who prepared or certified any part of the registration statement; and (5) all underwriters. Under Section 12(2) liability is imposed upon any person who offers or sells a security by means of a prospectus or oral communication which includes an untrue statement of material fact or an omission of a material fact. This would result in potential liability for Periwinkle, Ramses and Sheffield, Inc. (b) Under Section 11 all defendants have the defense available that Telford knew of the untruth at the time of purchase. Moreover, any defendant, other than the issuer, may assert the defense of due diligence. This defense generally requires a showing that the defendant had reasonable grounds to believe that there were no untrue statements or material omissions. In some instances, due diligence requires that a reasonable investigation be made. Under Section 12(2) the seller has the defense available that the purchaser knew of the untruth at the time of purchase. In addition, the seller may avoid liability by proving that he did not know, and in the exercise of reasonable care could not have known, of the untrue statement or omission. 8. Tanaka, a director and officer of Deep Hole Oil Company, telephoned Romani for the purpose of buying 200 shares of Deep Hole Company stock owned by Romani. During the period of negotiations, Tanaka concealed his identity and did not disclose the fact that earlier in the day he had received a report of two rich oil strikes on the oil company’s property. Romani sold his 200 shares to Tanaka for $10 per share. Taking into consideration the new strikes, the fair value of the stock was approximately $20 per share. Romani sues Tanaka to recover damages. Is Tanaka liable? If so, under which provisions and for what amount of money? Answer: 1934 Act: Antifraud Provision. Tanaka is liable for damages to Romani. Section 10(b) of the act and SEC Rule 10b-5 make it unlawful for any person by use of the mails or facilities of interstate commerce in connection with the purchase or sale of any security: (1) to employ any device, scheme, or artifice to defraud; (2) to make any untrue statement of a material fact; (3) to omit a material fact necessary to make the statements made not misleading; or (4) to engage in any act, practice, or course of business which operated or would operate as a fraud or deceit upon any person. Rule 10b-5 applies to any purchase or sale of any security, whether it is registered under the 1934 Act or not, whether it is publicly traded or closely held, whether it is listed on an exchange or sold over the counter. There are no exemptions. Unlike the liability provisions of the 1933 Act, Rule 10b-5 applies to misconduct of purchasers as well as sellers and allows both defrauded sellers and buyers to recover. As in this problem, when an insider possesses material information regarding a security, which information is non-public and that person has reason to know it is non-public, he may not buy or sell that security without first disclosing the "inside information" or waiting until the information becomes public. 9. Venable Corporation has 750,000 shares of common stock outstanding, which are owned by 2,640 shareholders. The assets of Venable Corporation are valued at more than $10 million. In March, Underhill began purchasing shares of Venable’s common stock in the open market. By April, he had acquired 40,000 shares at prices ranging from $12 to $14. Upon discovering Underhill’s activities in late April, the directors of Venable had the corporation purchase the 40,000 shares from Underhill for $18 per share. Which provisions of the 1934 Act, if any, have been violated? Answer: Tender Offers. Underhill has violated sections 13 and 14 of the 1934 Act regarding tender offers. Because Venable has assets in excess of $5 million and a class of equity securities with 500 or more shareholders, it is subject to the tender offer provisions of the 1934 Act. These provisions require any person that acquires more than 5 percent of a class of registered equity securities to file with the SEC a statement disclosing (1) the person's background, (2) the source of the funds used to acquire the securities, (3) the purpose of the acquisition, (4) the number of shares owned and (5) any relevant contracts, arrangements or understandings. Underhill became subject to this requirement when he acquired more than 37,500 shares. His failure to file the required disclosures is a violation of the 1934 Act and he is subject to civil and criminal sanctions. 10. Dirks was an officer of a New York broker-dealer firm who specialized in providing investment analysis of insurance company securities to institutional investors. On March 6, Dirks received information from Ronald Secrist, a former officer of Equity Funding of America. Secrist alleged that the assets of Equity Funding, a diversified corporation primarily engaged in selling life insurance and mutual funds, were vastly overstated as the result of fraudulent corporate practices. Dirks decided to investigate the allegations. He visited Equity Funding’s headquarters in Los Angeles and interviewed several officers and employees of the corporation. The senior management denied any wrongdoing, but certain corporation employees corroborated the charges of fraud. Neither Dirks nor his firm owned or traded any Equity Funding stock, but throughout his investigation he openly discussed the information he had obtained with a number of clients and investors. Some of these persons sold their holdings of Equity Funding securities, including five investment advisers who liquidated holdings of more than $16 million. While Dirks was in Los Angeles, he was in touch regularly with William Blundell, The Wall Street Journal’s Los Angeles bureau chief. Dirks urged Blundell to write a story on the fraud allegations. Blundell did not believe, however, that such a massive fraud could go undetected and declined to write the story. He feared that publishing such damaging hearsay might be libelous. During the two-week period in which Dirks pursued his investigation and spread word of Secrist’s charges, the price of Equity Funding stock fell from $26 per share to less than $15 per share. This led the New York Stock Exchange to halt trading on March 27. Shortly thereafter, California insurance authorities impounded Equity Funding’s records and uncovered evidence of the fraud. Only then did the Securities and Exchange Commission (SEC) file a complaint against Equity Funding. The SEC began an investigation into Dirks’s role in the exposure of the fraud. After a hearing by an administrative law judge, the SEC found that Dirks had aided and abetted violations of Section 10(b) of the Securities Exchange Act of 1934 and SEC Rule 10b–5 by repeating the allegations of fraud to members of the investment community who later sold their Equity Funding stock. Has Dirks violated Section 10(b) and Rule 10b–5? Explain. Answer: Insider Trading. No, Dirks has not violated either Section 10(b) or Rule 10b–5. Judgment for Dirks. An insider is liable under Rule 10b-5 for insider trading only when he does not disclose material, nonpublic information before trading on it and thus makes "secret profits." This duty to disclose before trading arises from a fiduciary relationship between the insider and the shareholders of the corporation. A "tippee" assumes such a duty only if he receives information from the insider improperly. This occurs (1) when the insider has breached his fiduciary duty to the shareholders by disclosure to the tippee, and (2) the tippee knows or should know of the breach. The test is whether the insider personally will benefit from his disclosure. Absent personal gain, there is no breach of duty to the stockholders and, therefore, no derivative breach by the tippee. Here, Dirks was a stranger to Equity Funding, with no fiduciary duty to its shareholders. The insiders who provided him with the information did not intend to receive monetary gain from the disclosure. Rather, they were motivated by a desire to expose the fraud. The insiders breached no duty to the shareholders of Equity Funding. Therefore, there was no derivative breach by Dirks. Dirks v. Securities and Exchange Commission, 463 U.S. 646, 103 S.Ct. 3255, 77 L.Ed.2d 911 (1983). 11. Texas Gulf Sulphur Company (TGS) was a corporation engaged in exploring for and mining certain minerals. A particular tract of Canadian land looked very promising as a source of desired minerals, and TGS drilled a test hole on November 8. Because the core sample of the hole contained minerals of amazing quality, TGS began to acquire surrounding tracts of land. Stevens, the president of TGS, instructed all on-site personnel to keep the find a secret. Because subsequent test drillings were performed, the amount of activity surrounding the drilling had resulted in rumors as to the size and quality of the find. To counteract these rumors, Stevens authorized a press release denying the validity of the rumors and describing them as excessively optimistic. The release was issued on April 12 of the following year, though drilling continued through April 15. In the meantime, several officers, directors, and employees had purchased or accepted options to purchase additional TGS stock on the basis of the information concerning the drilling. They also recommended similar purchases to outsiders without divulging the inside information to the public. At 10:00 A.M. on April 16, an accurate report on the find was finally released to the American financial press. The SEC brought this action against TGS and several of its officers, directors, and employees to enjoin conduct alleged to violate Section 10(b) of the Securities Act of 1934 and to compel rescission by the individual defendants of securities transactions assertedly conducted in violation of Rule 10b–5. Have any of the defendants violated Section 10(b)? Explain. Answer: Insider Trading. Judgment for SEC. Where corporate employees learn of information which is considered material as it relates to the investment market of their corporation's securities, they have no duty to disclose that information if there is a valid business reason for nondisclosure. However, these employees may not benefit from transactions in the corporation's securities until they effectively disclose the inside information to the public. Moreover, the corporation itself may be liable under Rule 10b-5 when it issues public statements relating to material information concerning a matter which could affect its stock in the market. In these public statements, the corporation must fully and fairly state facts upon which investors can reasonably rely. 1. Here, individual defendants had purchased TGS stock from November 12 through April 16 on the basis of material inside information concerning the results of TGS's drilling in Canada, while such information remained undisclosed to the investing public generally or to the particular sellers of the stock; 2. Some of the defendants had divulged such inside information to others for use in purchasing TGS stock or had recommended its purchase while the information was undisclosed to the public or to sellers; and 3. Some of the defendants had accepted options to purchase TGS stock on February 20 without disclosing the material information as to the drilling progress to either the Stock Option Committee or the TGS Board of Directors. Securities and Exchange Comm'n v. Texas Gulf Sulphur Co., 401 F.2d 833 (2nd Cir. 1968). 12. W. J. Howey Co. and Howey-in-the-Hills Service, Inc., were Florida corporations under direct common control and management. The Howey Company owned large tracts of citrus acreage in Florida. The service company cultivated, harvested, and marketed the crops. For several years, Howey Company offered one-half of its planted acreage to the public to help it “finance additional development.” Each prospective customer was offered both a land sales contract and a service contract with Howey-in-the-Hills after being told that it was not feasible to invest in the grove without a service arrangement. Upon payment of the purchase price, the land was conveyed by warranty deed. The service company was given full discretion over cultivating and marketing the crop. The purchaser had no right of entry to market the crop. The service company also was accountable only for an allocation of the net profits after the companies pooled the produce. The purchasers were predominantly nonresident businesspersons attracted by the expectation of substantial profits. Contending that this arrangement was an investment contract within the coverage of the Securities Act of 1933, the Securities and Exchange Commission brought an action against the two companies to restrain them from using the mails and instrumentalities of interstate commerce in the offer and sale of unregistered and nonexempt securities. Should the SEC succeed? Answer: Investment Contracts. Judgment for the SEC. The land sale and service contracts constitute an investment contract within the scope of the Securities Act of 1933. By including investment contracts within the act, Congress chose a more flexible definition of a security so as to include any contract, transaction, or scheme whereby a person invests his money in a common enterprise and is led to expect profits solely from the efforts of the promoter or a third party. Such a definition fulfills the statutory purpose of compelling full and fair disclosure relative to the issuance of the many types of instruments that in the commercial world fall within the ordinary concept of a security. The Securities Act prohibits the offer of unregistered, nonexempt securities as well as their sale. Therefore, if the companies merely offer the essential ingredients of an investment contract, that is enough to find a violation of the Securities Act. Securities and Exchange Com'n v. W.J. Howey Co., 328 U.S. 293 (1946). 13. Between December 4 and December 17, John Malone, a director and large shareholder of Discovery Communications, Inc. ("Discovery"), engaged in sales of Discovery's "Series C" stock totaling 953,506 shares and purchases of Discovery's "Series A" stock totaling 632,700 shares. Discovery's Series A stock and Series C stock are different equity securities, are separately registered, and are traded separately on the NASDAQ stock exchange under the ticker symbols DISCA and DISCK, respectively. The principal difference between the two securities is that Series A stock comes with voting rights whereas Series C stock does not confer any voting rights. Series A stock and Series C stock are not convertible into each other. A shareholder brought a shareholder suit seeking disgorgement of the profits that Malone realized from these transactions. Explain whether the plaintiff should succeed. Answer: Short-Swing Profits. The plaintiff should not succeed. An insider's purchase and sale of shares of different types of stock in the same company does not trigger liability under §16(b) of the 1934 Act, where those securities are separately traded, nonconvertible, and come with different voting rights. This problem is based on Gibbons v. Malone, 703 F.3d 595 (Court of Appeals, 2nd Circuit, 2013). Section 16(b) of the 1934 Act provides, in relevant part: For the purpose of preventing the unfair use of information which may have been obtained by such beneficial owner, director, or officer by reason of his relationship to the issuer, any profit realized by him from any purchase and sale, or any sale and purchase, of any equity security of such issuer ... within any period of less than six months ... shall inure to and be recoverable by the issuer, irrespective of any intention on the part of such beneficial owner, director, or officer in entering into such transaction.... This subsection shall not be construed to cover ... any transaction or transactions which the [SEC] by rules and regulations may exempt as not comprehended within the purpose of this subsection. 15 U.S.C. §78p(b). Notably, although §16(b) is designed to curb the use of nonpublic knowledge by corporate "insiders," see note 1, ante, the provision offers merely the "prophylactic" remedy of disgorgement, Blau v. Lehman, 368 U.S. 403, 414, 82 S.Ct. 451, 7 L.Ed.2d 403 (1962), and "operates mechanically, with no required showing of intent" to profit from the use of inside information, At Home Corp. v. Cox Commc'ns, Inc., 446 F.3d 403, 407 (2d Cir.2006). The statute, in other words, "imposes a form of strict liability." Credit Suisse Sec. (USA) LLC v. Simmonds, ___ U.S. ___, 132 S.Ct. 1414, 1417, 182 L.Ed.2d 446 (2012) (internal quotation marks omitted). As we have previously explained, "if the conversion can be paired with another ‘sale' or ‘purchase,' and the paired transactions occur within a six month period, the paired transactions are ... the type of insider activity that Section 16(b) was designed to prevent," Blau v. Lamb, 363 F.2d 507, 517 (2d Cir.1966), but transactions of securities that cannot be "paired" are not within the scope of §16(b). Cf. Foremost-McKesson, Inc. v. Provident Sec. Co., 423 U.S. 232, 243-44, 96 S.Ct. 508, 46 L.Ed.2d 464 (1976) (short-swing profit rule applies to profits realized from "a pair" of securities transactions). The question presented is whether a sale of one security and a purchase of a different security issued by the same company can be "paired" under §16(b). Congress's use of the singular term "any equity security" supports an inference that transactions involving different equity securities cannot be paired under §16(b). See At Home Corp., 446 F.3d at 408-09. As the District Court explained, correctly in our view: The text limits liability to profits realized from "the purchase and sale, or sale and purchase, of any equity security of the issuer." The drafters specifically chose to group "purchase and sale" and "sale and purchase" into single compounded units. This indicates that, to incur Section 16(b) liability, an insider's "purchase and sale" or "sale and purchase" must both be directed at the same prepositional object—i.e. the same equity security. Gibbons, 801 F.Supp.2d at 247; cf. Am. Standard, Inc. v. Crane Co., 510 F.2d 1043, 1058 (2d Cir.1974) ("The statute speaks of `such issuer' in the singular. There is no room for a grammatical construction that would convert the singular into a plural."). The regulations promulgated by the SEC implicitly support this understanding of §16(b) by noting that that the statute covers the purchase and sale, or sale and purchase, of "a security," and by providing for an exception when the purchase and sale of "such security" meets certain conditions. 17 C.F.R. §240.16b-1. *** Accordingly, as we recently observed in passing, §16(b) applies to the purchase and sale, or sale of purchase, of "the same security." Analytical Surveys, Inc. v. Tonga Partners, L.P., 684 F.3d 36, 43 (2d Cir.2012). Indeed, it has been our longstanding view that although §16(b) "might be read literally to permit a recovery where stock of one class is purchased and stock of another class sold," the likelihood "that Congress intended such a result is beyond the realm of judicial fantasy." Smolowe v. Delendo Corp., 136 F.2d 231, 237 n. 13 (2d Cir.1943) (emphasis supplied). *** Discovery's Series A stock and Series C stock, however, are readily distinguishable. Most importantly, Series A shares confer voting rights, whereas Series C shares do not. The two securities, therefore, are distinct not merely in name but also in substance. An insider could easily prefer one security over the other for reasons not related to short-swing profits. *** To summarize, we hold that an insider's purchase and sale of shares of different types of stock in the same company does not trigger liability under §16(b) of the Securities Exchange Act of 1934, 15 U.S.C. §78p(b), where those securities are separately traded, nonconvertible, and come with different voting rights. ANSWERS TO “TAKING SIDES” PROBLEMS Basic, Inc. was a publicly traded company. Combustion Engineering, Inc. and Basic began discussions concerning the possibility of a merger of the two companies. During the next two years, Basic made three public statements denying that it was engaged in merger negotiations. In December of the second year, Basic publicly announced its approval of Combustion’s offer for all its outstanding shares. Former owners of Basic stock who sold their shares after Basic publicly denied that it was engaged in merger negotiations brought a class action suit against Basic and its directors for having released false or misleading information in violation of Section 10(b) of the 1934 Act and Rule 10b–5. The plaintiffs claimed that they were injured by selling their shares at prices that were artificially depressed as a consequence of Basic’s misleading public statements. The defendants claimed that the plaintiffs had not proven that the plaintiffs had, in fact, relied upon the misleading statements in selling their stock. (a) What are the arguments that the plaintiffs have satisfied the reliance requirement of Section 10(b) of the 1934 Act and Rule 10b–5? (b) What are the arguments that the plaintiffs have not satisfied the reliance requirement of Section 10(b) of the 1934 Act and Rule 10b–5? (c) Which side should prevail? Answer: (a) The plaintiffs could argue that they had traded Basic shares in reliance on the integrity of the price set by the market. Because of the defendants’ material misrepresentations, that price had been fraudulently depressed. Under the “fraud-on-the-market” theory, in an efficient stock market misleading statements will defraud purchasers of stock even if the purchasers do not directly rely on the misstatements. (b) The defendants could oppose the fraud-on-the-market theory by arguing that it effectively eliminates the requirement of proving reliance in claims under Section 10(b) of the 1934 Act and Rule 10b-5. Applying the fraud-on-the-market theory would result in the unfair result of permitting someone who sold Basic shares to recover for fraud even if the seller did not believe the defendants’ misleading statements. The defendants could also argue that at the time of the statements Basic was merely in preliminary negotiations and any statement would have been premature and in itself misleading. (c) The former shareholders should prevail. Basic Inc. v. Levinson, 485 U.S. 224, 108 S.Ct. 978, 99 L.Ed.2d 194, Supreme Court of United States, 1988. A person who traded a corporation’s shares on a securities exchange after the issuance of a materially misleading statement by the corporation may invoke a rebuttable presumption that, in trading, he relied on the integrity of the price set by the market. The Court of Appeals found that Basic “made public, material misrepresentations” and found that the shareholders “sold Basic stock in an impersonal, efficient market.” The plaintiffs thereby “established the threshold facts for proving their loss.” The lower court was correct in applying a rebuttable presumption of reliance supported in part by the “fraud-on-the-market” theory, instead of requiring each plaintiff to show individual direct reliance on Basic’s statements. A presumption of reliance upon public information is warranted in an impersonal, efficient market. It would be extremely burdensome to require plaintiffs to prove that they personally knew about the misleading or false information and actually relied upon it. A presumption of reliance also is consistent with the legislative policy embodied in the 1934 Act. Congress expressly relied upon the fact that securities markets are affected by information and that a free and open market relies upon the theory that the market price reflects a just price. Furthermore, a presumption of reliance is supported by empirical evidence and common sense. Studies have confirmed the fact that market price generally reflects all publicly available information, and reasonable people would not take the risk of trading in a market in which such integrity of market price did not exist. Any showing that severs the link between the alleged misrepresentation and either the price received (or paid) by the plaintiff, or his decision to trade at a fair market price, will be sufficient to rebut the presumption of reliance. Solution Manual for Smith and Robersons Business Law Richard A. Mann, Barry S. Roberts 9781337094757, 9780357364000, 9780538473637
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