Chapter 43 SECURITIES REGULATION The Securities Act of 1933 Definition of a Security [43-1] Registration of Securities [43-2] Disclosure Requirements [43-2a] Integrated Disclosure [43-2b] Shelf Registrations [43-2c] Communications [43-2d] Emerging Growth Companies (EGCs) [43-2e] Exempt Securities [43-3] Short-term Commercial Paper [43-3a] Other Exempt Securities [43-3b] Exempt Transactions for Issuers [43-4] Limited Offers [43-4a] Private Placements Limited Offers Not Exceeding $5 Million Limited Offers Not Exceeding $1 Million Limited Offers Solely to Accredited Investors Crowdfunding Exemption [43-4b] Regulation A [43-4c] Intrastate Issues [43-4d] Exempt Transactions for NonIssuers [43-5] Rule 144 [43-5a] Nonreporting Issuers Reporting Issuers Regulation A [43-5b] Liability [43-6] Unregistered Sales [43-6a] False Registration Statements [43-6b] Antifraud Provision [43-6c] Criminal Sanctions [43-6d] The Securities Exchange Act of 1934 Disclosure [43-7] Registration Requirements for Securities [43-7a] Periodic Reporting Requirements [43-7b] Proxy Solicitations [43-7c] Proxy Statements Shareholder Proposals Tender Offers [43-7d] Disclosure Requirements Required Practices Defensive Tactics State Regulation Foreign Corrupt Practices Act [43-7e] Liability [43-8] Misleading Statements in Reports [43-8a] Short-Swing Profits [43-8b] Antifraud Provision [43-8c] Requisites of Rule 10b-5 Insider Trading Express Insider Trading Liability [43-8d] Civil Monetary Penalties for Insider Trading [43-8e] Misleading Proxy Statements [43-8f] Fraudulent Tender Offers [43-8g] Antibribery Provision of FCPA [43-8h] Criminal Sanctions [43-8i] Cases in This Chapter SEC v. Edwards Omnicare, Inc. v. Laborers District Council Construction Industry Pension Fund Matrixx Initiatives, Inc. v. Siracusano United States v. o’Hagan Schreiber v. Burlington Northern, Inc. Chapter Outcomes After reading and studying this chapter, the student should be able to: • Explain the disclosure requirements of the 1933 Act, including which securities and transactions are exempt from these disclosure requirements. • Explain the potential civil liabilities under the 1933 Act. • List which provisions of the 1934 Act apply only to publicly held companies and which apply to all companies. • Explain the disclosure requirements of the 1934 Act. • Explain the potential civil liabilities under the 1934 Act. TEACHING NOTES The primary purpose of Federal securities regulation is to foster public confidence in the securities market by preventing fraudulent practices in the sale of securities. Federal securities law consists principally of two statutes: the Securities Act of 1933, which focuses on the issuance of securities, and the Securities Exchange Act of 1934, which deals mainly with trading in issued securities. The 1933 Act has two basic objectives: (1) to provide investors with material information concerning securities offered for sale to the public and (2) to prohibit misrepresentation, deceit, and other fraudulent acts and unfair practices in the sale of securities generally, whether or not they are required to be registered. (3) The 1934 Act extends protection to investors trading in securities that are already issued and outstanding. The 1934 Act also imposes disclosure requirements on publicly held corporations and regulates tender offers and proxy solicitations. Both statutes are administered by the Securities and Exchange Commission (SEC), an independent, quasi-judicial agency consisting of five commissioners. The responsibilities of the SEC include interpreting Federal securities laws; issuing new rules and amending existing rules; and coordinating U.S. securities regulation with Federal, State, and foreign authorities. Congress enacted the Private Securities Litigation Reform Act of 1995 (Reform Act), which amends both the 1933 Act and the 1934 Act. One of its provisions grants authority to the SEC to bring civil actions for specified violations of the 1934 Act against aiders and abettors (those who knowingly provide substantial assistance to a person who violates the statute). The Reform Act sought to prevent abuses in private securities fraud lawsuits. To prevent certain State private securities class action lawsuits alleging fraud from being used to frustrate the objectives of the Reform Act, Congress enacted the Securities Litigation Uniform Standards Act of 1998. The Act sets national standards for securities class action lawsuits involving nationally traded securities, while preserving the appropriate enforcement powers of State securities regulators and leaving unchanged the current treatment of individual lawsuits.. In response to the business scandals involving companies such as Enron, WorldCom, Global Crossing, Adelphia, and Arthur Andersen, in 2002 Congress passed the Sarbanes-Oxley Act, which amends the securities acts in a number of significant respects. The Act allows the SEC to add civil penalties to a disgorgement fund for the benefit of victims of violations of the 1933 Act or the 1934 Act In July 2010, President Obama signed into law the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act), including the Investor Protection and Securities Reform Act of 2010, which imposes new corporate governance and investor protection rules on publicly held companies. The Dodd-Frank Act has extended the SEC’s authority in two ways: (1) the Dodd-Frank Act empowers the SEC to bring enforcement actions under the 1933 Act against aiders and abettors and (2) the Dodd-Frank Act amends the 1933 and 1934 Acts to allow recklessness as well as knowledge to satisfy the mental state required for the SEC to bring aiding and abetting cases. In addition, the Dodd-Frank Act requires the SEC to make an award to whistleblowers who voluntarily provide original information that leads to a successful enforcement action in which the SEC imposes monetary sanctions in excess of $1 million. The amount of the award must be between 10 percent and 30 percent of funds collected as monetary sanctions, as determined by the SEC. To increase U.S. job creation and economic growth by improving access to the public capital markets for emerging growth companies, Congress enacted the Jumpstart Our Business Startups Act of 2012 (JOBS Act). As discussed later in this chapter, the JOBS Act amends both the 1933 Act and the 1934 Act to provide reduced disclosure requirements for emerging growth companies (defined as companies with total annual gross revenues of less than $1 billion during their last completed fiscal year) and to expand the availability of exemptions from registering securities under the 1933 Act. The SEC has established the EDGAR (Electronic Data Gathering, Analysis, and Retrieval) computer system, which performs automated collection, validation, indexing, acceptance, and dissemination of reports required to be filed with the SEC. In addition to the Federal laws regulating the sale of securities, each State has its own laws regulating such sales within its borders. Commonly called blue sky laws, these statutes all contain provisions prohibiting fraud in the sale of securities. In addition, most States require the registration of securities and also regulate brokers and dealers. The Uniform Securities Act of 1956 has been adopted at one time or another, in whole or in part, by thirty-seven jurisdictions, whereas the Revised Uniform Securities Act of 1985 has been adopted in only a few States. Both Acts, however, have been preempted in part by the National Securities Markets Improvement Act of 1996 and the Securities Litigation Uniform Standards Act of 1998. In 2002 the National Conference of Commissioners on Uniform State Laws promulgated a new Uniform Securities Act, which has been adopted by at least nineteen States. The 2002 Uniform Securities Act seeks to give States regulatory and enforcement authority that minimizes duplication of regulatory resources and that blends with Federal regulation and enforcement. . THE SECURITIES ACT OF 1933 This act, also known as the “Truth in Securities Act,” requires that a registration statement be filed with the SEC and that it become effective before any securities may be offered for sale to the public, unless the transaction in which the securities are offered is exempt or the securities themselves are exempt from registration. • The purpose of registration is to disclose financial and other information about the issuer and those who control it so that potential investors may consider the merits of the securities. • The act also requires that potential investors be furnished with a prospectus containing important data set forth in the registration statement. • The 1933 Act apply to all sales of securities involving interstate commerce or the mails, even if the securities are exempt from the 1933 Act’s registration and disclosure requirements. • Civil and criminal liability may be imposed for violations of the act. The National Securities Market Improvements Act of 1996 authorizes the SEC to issue exemptions in certain cases when in the best public interest. 43-1 DEFINITION OF A SECURITY The 1933 Act defines a security as any note, stock, bond, debenture, evidence of indebtedness, pre-organization certificate of subscription, investment contract, voting-trust certificate, fractional undivided interest in oil, gas, or other mineral rights, or any interest or instrument commonly known as a security. Courts have interpreted the term “investment contract” to require an investment of money or other consideration and an expectation of profit derived from the efforts of others. Thus, limited partnership interests are usually considered securities because limited partners may not participate in management or control of the partnership. On the other hand, general partnership interests are usually held not to be securities because general partners have the right to participate in management of the general partnership. CASE 43-1 SEC v. EDWARDS Supreme Court of the United States, 2004 540 U.S. 389, 124 S.Ct. 892, 157 L.Ed.2d 813 http://scholar.google.com/scholar_case?q=540+U.S.+389&hl=en&as_sdt=2,34&case=14322712118728699297&scilh=0 O’Connor, J. “Opportunity doesn’t always knock * * * sometimes it rings.” [Citation.] And sometimes it hangs up. So it did for the 10,000 people who invested a total of $300 million in the payphone sale-and-leaseback arrangements touted by respondent under that slogan. The Securities and Exchange Commission (SEC) argues that the arrangements were investment contracts, and thus were subject to regulation under the federal securities laws. In this case, we must decide whether a moneymaking scheme is excluded from the term “investment contract” simply because the scheme offered a contractual entitlement to a fixed, rather than a variable, return. I Respondent Charles Edwards was the chairman, chief executive officer, and sole shareholder of ETS Payphones, Inc. (ETS). ETS, acting partly through a subsidiary also controlled by respondent, sold payphones to the public via independent distributors. The payphones were offered packaged with a site lease, a 5-year leaseback and management agreement, and a buyback agreement. All but a tiny fraction of purchasers chose this package, although other management options were offered. The purchase price for the payphone packages was approximately $7,000. Under the leaseback and management agreement, purchasers received $82 per month, a 14% annual return. Purchasers were not involved in the day- to-day operation of the payphones they owned. ETS selected the site for the phone, installed the equipment, arranged for connection and long-distance service, collected coin revenues, and maintained and repaired the phones. Under the buyback agreement, ETS promised to refund the full purchase price of the package at the end of the lease or within 180 days of a purchaser’s request. In its marketing materials and on its website, ETS trumpeted the “incomparable pay phone” as “an exciting business opportunity,” in which recent deregulation had “open[ed] the door for profits for individual pay phone owners and operators.” According to ETS, “[v]ery few business opportunities can offer the potential for ongoing revenue generation that is available in today’s pay telephone industry.” [Citation.] The payphones did not generate enough revenue for ETS to make the payments required by the leaseback agreements, so the company depended on funds from new investors to meet its obligations. In September 2000, ETS filed for bankruptcy protection. The SEC brought this civil enforcement action the same month. It alleged that respondent and ETS had violated the registration requirements of §§5(a) and (c) of the Securities Act of 1933, [citation], the antifraud provisions of both §17(a) of the Securities Act of 1933, [citation], and §10(b) of the Securities Exchange Act of 1934, [citation], and Rule 10b-5 thereunder, [citation]. The District Court concluded that the payphone sale-and-leaseback arrangement was an investment contract within the meaning of, and therefore was subject to, the federal securities laws. [Citation.] The Court of Appeals reversed. [Citation.] It held that respondent’s scheme was not an investment contract, on two grounds. First, it read this Court’s opinions to require that an investment contract offer either capital appreciation or a participation in the earnings of the enterprise, and thus to exclude schemes, such as respondent’s, offering a fixed rate of return. [Citation.] Second, it held that our opinions’ requirement that the return on the investment be “derived solely from the efforts of others” was not satisfied when the purchasers had a contractual entitlement to the return. [Citation.] We conclude that it erred on both grounds. II “Congress’ purpose in enacting the securities laws was to regulate investments, in whatever form they are made and by whatever name they are called.” [Citation.] To that end, it enacted a broad definition of “security,” sufficient “to encompass virtually any instrument that might be sold as an investment.” [Citation.] * * * [The 1993 Act and the 1934 Act] define “security” to include “any note, stock, treasury stock, security future, bond, debenture, * * * investment contract, * * * [or any] instrument commonly known as a ‘security’” “Investment contract” is not itself defined. The test for whether a particular scheme is an investment contract was established in our decision in SEC v. W. J. Howey Co., [citation]. We look to “whether the scheme involves an investment of money in a common enterprise with profits to come solely from the efforts of others.” [Citation.] This definition “embodies a flexible rather than a static principle, one that is capable of adaptation to meet the countless and variable schemes devised by those who seek the use of the money of others on the promise of profits.” [Citation.] * * * Thus, when we held that “profits” must “come solely from the efforts of others,” we were speaking of the profits that investors seek on their investment, not the profits of the scheme in which they invest. We used “profits” in the sense of income or return, to include, for example, dividends, other periodic payments, or the increased value of the investment. There is no reason to distinguish between promises of fixed returns and promises of variable returns for purposes of the test, so understood. In both cases, the investing public is attracted by representations of investment income, as purchasers were in this case by ETS’ invitation to “‘watch the profits add up.”’ [Citation.] Moreover, investments pitched as low-risk (such as those offering a “guaranteed” fixed return) are particularly attractive to individuals more vulnerable to investment fraud, including older and less sophisticated investors. [Citation.] * * * * * * We hold that an investment scheme promising a fixed rate of return can be an “investment contract” and thus a “security” subject to the federal securities laws. The judgment of the United States Court of Appeals for the Eleventh Circuit is reversed, and the case is remanded for further proceedings consistent with this opinion. It is so ordered. 43-2 REGISTRATION OF SECURITIES The purpose of registration is to disclose financial and other information adequate and accurate enough to enable investors to judge the merits of securities. Registration does not insure against loss — the SEC does not judge the merits of any security or guarantee accuracy of information in a registration statement. 43-2a Disclosure Requirements Registration calls for (1) a description of the registrant’s properties and business, (2) a description of the significant provisions of the security to be offered for sale and its relationship to the registrant’s other capital securities, (3) information about the management of the registrant, and (4) financial statements certified by independent public accountants. In 1992, the SEC imposed new disclosure requirements regarding compensation paid to senior executives and directors. In 2006 the SEC amended these rules to mandate clearer and more complete disclosure of compensation paid to directors, the chief executive officer (CEO), the chief financial officer (CFO), and the three other highest-paid executive officers. The registration statement must be signed by the issuer, its CEO, its CFO, its chief accounting officer, and a majority of its board of directors. A registration statement and the prospectus become public immediately on filing with the SEC, and investors can access them using EDGAR. In 1998 the SEC issued a rule requiring issuers to write and design the cover page, summary, and risk factors section of their prospectuses in plain English. After the effective date, the issuer may make sales, provided the purchaser has received a final prospectus. 43-2b Integrated Disclosure Integrated disclosure is permitted for issuers subject to both the 1933 and 1934 Acts in an effort to reduce or eliminate unnecessary duplication of reporting. This integrated system provides for different levels of disclosure, depending on the issuer’s reporting history and market following. All issuers may use the detailed form (S–1) described previously. Effective December 1, 2005 the SEC amended these rules to recognize four categories of issuers: non-reporting issuers, unseasoned issuers, seasoned issuers, and well-known seasoned issuers. 1. A non-reporting issuer is an issuer that is not required to files reports under the 1934 Act. Such an issuer must use Form S-1. 2. An unseasoned issuer is an issuer that has reported continuously under the 1934 Act for at least three years. Such an issuer must use Form S-1 but is permitted to disclose less detailed information and to incorporate some information by reference to reports filed under the 1934 Act. 3. A seasoned issuer is an issuer that has filed continuously under the 1934 Act for at least one year and has a minimum market value of publicly held voting and nonvoting stock of $75 million. Such an issuer is permitted to use Form S-3 thus disclosing even less detail in the 1933 Act registration and incorporating even more information by reference to 1934 Act reports. 4. A well-known seasoned issuer is an issuer that has filed continuously under the 1934 Act for at least one year and has either (a) a minimum worldwide market value of its outstanding publicly held voting and nonvoting stock of $700 million or (b) $1 billion of non-convertible debt or preferred stock that have been issued for cash in a registered offering within the preceding three years. A well-known seasoned issuer is also eligible to use Form S -3. In 1992, the SEC adopted a new form (called SB-1) for use by small businesses who sell up to $10 million of securities in a 12-month period. . As amended in 2008, the rules define a small business issuer as a noninvestment company with less than $75 million in public float. When a company is unable to calculate public float, however, the standard is less than $50 million in revenue in the last fiscal year. 43-2c Shelf Registrations Shelf registrations permit certain qualified issuers to register securities that are to be offered and sold “off the shelf” on a delayed or continuous basis within two years. The information in the original registration must be kept accurate and current. As amended in 2005, shelf registrations permit seasoned and well-known seasoned issuers to register unlimited amounts of securities that are to be offered and sold “off the shelf” on a delayed or continuous basis in the future. 43-2d Communications The SEC’s 2005 revisions greatly liberalize the rules regarding written communications before and during registered securities offerings. These rules create a new type of written communication, called a “free-writing prospectus,” which is any written offer, including electronic communications, other than a statutory prospectus. The flexibility provided under the new rules depends upon the characteristics of the issuer, including the type of issuer, the issuer’s history of reporting, and the issuer’s market capitalization. 1. Well-known seasoned issuers may engage at any time in oral and written communications, including a free writing prospectus, subject to certain conditions. 2. All reporting issuers (unseasoned issuers, seasoned issuers, and well-known seasoned issuers) may at any time continue to publish regularly released factual business information and forward-looking information (predictions). 3. Non-reporting issuers may at any time continue to publish factual business information that is regularly released and intended for use by persons other than in their capacity as investors or potential investors. 4. Communications by issuers more than thirty days before filing a registration statement are permitted so long as they do not refer to a securities offering that is the subject of a registration statement. 5. All issuers may use a free writing prospectus after the filing of the registration statement, subject to certain conditions. 43-2e Emerging Growth Companies The JOBS Act defines an emerging growth company (EGC) as a domestic or foreign issuer with total annual gross revenues of less than $1 billion (periodically adjusted for inflation) during its most recently completed fiscal year if that issuer did not first sell common equity securities in an initial public offering (IPO) on or before December 8, 2011. An issuer continues to be deemed to be an EGC until the earliest of the following: (1) it has annual gross revenues of $1 billion, as adjusted for inflation, or more; (2) five years after its IPO; (3) the date on which the issuer has, or had during the previous three-year period, issued more than $1 billion in nonconvertible debt; and (4) the date on which it is deemed to be a “large accelerated filer” pursuant to SEC rules. The JOBS Act reduces the financial reporting requirements, and therefore the cost, in connection with an EGC’s IPO. *** Chapter Outcome *** Explain the disclosure requirements of the 1933 Act, including which securities and transactions are exempt from these disclosure requirements. 43-3 EXEMPT SECURITIES The 1933 Act exempts a number of specific securities from its registration requirements; these are known as exempt securities. The securities may also be resold without registration, because the exemption applies to the securities themselves. 43-3a Short-Term Commercial Paper The act exempts any note, draft, or bankers’ acceptance (a draft accepted by a bank) issued for working capital, that has a maturity of not more than nine months when issued. This exemption is not available if the proceeds are to be used for permanent purposes, such as the acquisition of a plant, or if the paper is of a type not ordinarily purchased by the general public. 43-3b Other Exempt Securities These include, under the 1933 Act: (1) securities issued or guaranteed by domestic governments, such as municipal bonds; (2) securities of domestic banks and savings and loan associations; (3) securities of nonprofit charitable organizations; (4) certain securities issued by federally regulated common carriers; and (5) insurance policies and annuity contracts issued by state-regulated insurance companies. The Bankruptcy Code exempts securities issued by a debtor under a reorganization plan in exchange for a claim or interest in the debtor. NOTE: See Figure 43-1: Registration and Exemptions under the 1933 Act 43-4 EXEMPT TRANSACTIONS FOR ISSUERS 43-4a Limited Offers In addition to exempting specific types of securities, the 1933 Act also exempts issuers from the registration requirements for certain kinds of transactions. These exempt transactions include (1) private placements (Rule 506), (2) limited offers not exceeding $5 million (Rule 505), (3) limited offers not exceeding $1 million (Rule 504) and (4) limited offers solely to accredited investors (Section 4(6)). If the issuance meets certain conditions, Rule 504 permits general solicitations, and acquired shares are freely transferable. The conditions are that the issuance is either (1) registered under State law requiring public filing and delivery of a disclosure document to investors before sale or (2) exempted under State law permitting general solicitation and advertising so long as sales are made only to accredited investors. If the issuance does not meet these conditions, general solicitation and advertising is not permitted. Moreover, the securities issued are restricted, and the issuer must take precautions against nonexempt, unregistered resales. Each of these exemptions requires the issuer to file a Form D with the SEC online within fifteen days after the first sale of securities in the offering. Moreover, the Dodd-Frank Act requires the SEC to issue rules disqualifying offerings and sales of securities made under Regulation D offering when the person offering the securities has been convicted of any felony or misdemeanor (1) in connection with the purchase or sale of any security or (2) involving the making of any false filing with the SEC. The JOBS Act added Section 4(a)(6) providing a new crowdfunding exemption from registration that will allow eligible, domestic, nonpublic issuers to raise up to $1 million (periodically adjusted for inflation) annually. The 1933 Act identifies a number of securities exemptions that are in effect transaction exemptions: intrastate issues, exchanges between an issuer and its security holders, and reorganization securities issued and exchanged with court or other governmental approval. These exemptions apply only to the original issuance; resales may be made only by registration, unless the resale qualifies as an exempt transaction. 43-4b Crowdfunding Exemption Crowdfunding is the use of the Internet to raise small amounts of money from a large number of contributors. The JOBS Act requires the SEC to adopt rules to implement a new crowdfunding exemption from registration that will allow eligible, domestic, nonpublic issuers to raise up to $1 million (periodically adjusted for inflation) annually. This crowdfunding exemption permits the sale of limited amounts of stock to a large number of individuals, whether accredited or not, through brokers or a new category of intermediaries, funding portals. Effective on May 16, 2016, the SEC adopted Regulation Crowdfunding, which permits individuals to invest in securities-based crowdfunding transactions subject to certain thresholds, limits the amount of money an issuer can raise under the crowdfunding exemption, requires issuers to disclose certain information about their offers, and creates a regulatory framework for the intermediaries that facilitate the crowdfunding transactions. The following summarizes the key provisions: An issuer is permitted to raise a maximum aggregate amount of $1 million through crowdfunding offerings in a 12-month period. Over the course of a 12-month period, individual investors’ combined investments in securities sold under the exemption are limited based on an income and net worth test. Issuers that are not eligible to use the Regulation Crowdfunding exemption include non-U.S. companies, companies that already are 1934 Act reporting companies, certain investment companies, companies that are disqualified under Regulation Crowdfunding’s disqualification rules, companies that have failed to comply with the annual reporting requirements under Regulation Crowdfunding during the two years immediately preceding the filing of the offering statement, and companies that have no specific business plan or have indicated their business plan is to engage in a merger or acquisition with an unidentified company or companies. Issuers must file certain information, including financial information, with the SEC via EDGAR and provide this information to investors and the relevant intermediary facilitating the crowdfunding offering. Offerings must be conducted exclusively through a platform operated by a registered broker or a funding portal, which is a new type of SEC registrant. Securities cannot be resold for a period of one year subject to certain limited exceptions, including resales to the issuer, to an accredited investor, as part of a registered offering, and to a family member of the purchaser. An issuer’s advertising notice that includes the terms of the offering can include no more than: (a) a statement that the issuer is conducting an offering, the name of the intermediary through which the offering is being conducted, and a link directing the investor to the intermediary’s platform; (b) the terms of the offering including the amount of securities offered, the nature of the securities, the price of the securities, and the closing date of the offering period; and (c) specified factual information about the company’s legal identity and its business location. Holders of securities sold pursuant to this exemption do not count toward the threshold that requires an issuer to register its securities with the SEC under Section 12 of the 1934 Act (discussed later) if the issuer (a) is current in its annual reporting obligation, (b) retains the services of a registered transfer agent, and (c) has less than $25 million in assets. 43-4c Regulation A Regulation A permits U.S. and Canadian issuers to offer up to $5 million of securities in any twelve-month period without registering them, subject to eligibility, disclosure, and reporting requirements. To expand the availability of Regulation A for issuers, the JOBS Act directs the SEC to amend Regulation A to allow an exemption from registration for offerings of up to $50 million within any twelve-month period. On March 25, 2015, the SEC implemented the JOBS Act mandate by adopting final rules, referred to as “Regulation A+,” that enable companies to offer and sell up to $50 million of securities in a rolling twelve-month period in public offerings without complying with the normal registration requirements of the 1933 Act. The final rules provide for two tiers of offerings: Tier 1, for offerings of up to $20 million, and Tier 2, for offerings of up to $50 million. The following requirements apply to both Tier 1 and Tier 2 offerings. For offerings of up to $20 million, issuers may elect whether to proceed under Tier 1 or Tier 2. Tier 1 Tier 1 of Regulation A+, which is available for offerings up to $20 million per twelve-month period, imposes (1) no restrictions regarding the number or qualifications of investors who may purchase securities and (2) no ongoing reporting requirements. Tier 1 offerings remain subject to the registration and qualification requirements of State Blue Sky securities laws. Tier 2 Tier 2 of Regulation A+, which is available for offerings up to $50 million per twelve-month period, imposes additional reporting requirements that include providing audited financial statements in the offering statement and filing annual, semiannual, and current event reports with the SEC electronically on EDGAR. The amount of securities that a nonaccredited investor can purchase in a Tier 2 offering is limited to no more than 10% of the greater of the investor’s annual income or net worth, unless the securities are listed on a national securities exchange. These investment limitations, however, do not apply to investors who qualify as accredited investors under Regulation D. Regulation A+ provides Tier 2 issuers preemption from the registration and qualification requirements of State Blue Sky securities laws. 43-4d Intrastate Issues This exemption covers a security that is offered and sold only to residents of one state. The issuer must be incorporated or organized in the state of issuance and must conduct 80 percent of its business in the state. No resale of these securities is permitted for nine months. NOTE: See Figure 43-2: Exempt Transactions for Issuers under the 1933 Act. 43-5 EXEMPT TRANSACTIONS FOR NONISSUERS 43-5a Rule 144 Rule 144 exempts certain resales of restricted securities. If there is adequate current information about the issuer, the seller has held the security for two years, the securities are sold in limited amounts and in unsolicited brokers' transactions, and the SEC is notified of the sale, then the resale is exempt. A seller unaffiliated with the issuer who has held the securities for three years may resell without restriction. As amended in 2008, the rule imposes less strict requirements on resales of securities of issuers that are subject to the reporting requirements of the 1934 Act than on resales of securities of nonreporting issuers. Nonreporting Issuers Amended Rule 144 — requires for an affiliate selling restricted securities that there be adequate current public information about the issuer, that the affiliate selling under the rule have owned the restricted securities for at least one year, that she sell them only in limited amounts in unsolicited brokers’ transactions, and that notice of the sale be provided to the SEC. An affiliate selling nonrestricted securities is subject to the same requirements except that the one-year holding period does not apply. A person who is not an affiliate of the issuer when the restricted securities are sold and who has owned the restricted securities for at least one year may sell them in unlimited amounts and is not subject to any of the other requirements of Rule 144. Reporting Issuers Amended Rule 144 — requires for an affiliate selling restricted securities that there be adequate current public information about the issuer, that the affiliate selling under the rule have owned the restricted securities for at least six months, that she sell them only in limited amounts in unsolicited brokers’ transactions, and that notice of the sale be provided to the SEC. An affiliate selling nonrestricted securities is subject to the same requirements except for the one-year holding period. If there is adequate current public information about the issuer, a person who is not an affiliate of the issuer when the restricted securities are sold and has owned the restricted securities for at least six months may sell them in unlimited amounts and is not subject to any of the other requirements of Rule 144. After one year, the nonaffiliate selling restricted securities need not comply with the current information requirement of Rule 144. 43-5b Rule 144A To improve the liquidity of restricted securities, in 1990 the SEC adopted Rule 144A, which provides an additional, nonexclusive safe harbor from registration for resales of restricted securities. Only securities that at the time of issue are not of the same class as securities listed on a national securities exchange or quoted in a U.S. automated interdealer quotation system (“nonfungible securities”) may be sold under Rule 144A. Such nonfungible securities may be sold only to a qualified institutional buyer, defined generally as an institution that in the aggregate owns and invests on a discretionary basis at least $100 million in securities. In 2013, the SEC amended Rule 144A to provide that securities may be offered pursuant to Rule 144A to persons other than qualified institutional buyers, provided that the securities are sold only to persons that the seller reasonably believes are qualified institutional buyers. Rule 144A also requires the seller of the nonfungible securities to take reasonable steps to ensure that the buyer knows that the seller is relying on Rule 144A. In addition, special requirements apply to securities issued by foreign companies. Securities acquired pursuant to Rule 144A are restricted securities. 43-5c Regulation A Also provides a registration exemption for resales of a limited amount of securities by non-issuers. 43-6 LIABILITY The 1933 Act imposes sanctions for noncompliance with its requirements, including administrative remedies by the SEC, civil liability to injured investors, and criminal penalties. The Reform Act provides a safe harbor from liability for a prediction or other “forward-looking” statement if it is immaterial, or made without knowledge of its falsity, or identified as a forward-looking statement and accompanied by cautionary statements that actual results may differ. *** Chapter Outcome *** Discuss the potential civil liabilities under the 1933 Act. 43-6a Unregistered Sales Section 12(1) of the act imposes express civil liability for • the sale of an unregistered security that is required to be registered, • the sale of a registered security without delivery of a prospectus, • the sale of a security by use of an outdated prospectus, • or the offer of a sale before the filing of the registration statement. Liability is strict, or absolute; there are no defenses. The person who purchases a security sold in violation of this provision has the right to tender it back to the seller and recover the purchase price. If the purchaser no longer owns the security, he may recover monetary damages from the seller. 43-6b False Registration Statements Section 11 of the act imposes express liability on those who have included any untrue statement of a material fact in the registration statement or who have omitted any material fact from it. Material matters are those to which a reasonable investor would be substantially likely to attach importance in determining whether to purchase the security registered. Liability is imposed on (1) the issuer; (2) all persons who signed the registration statement, including the principal executive officer, principal financial officer, and principal accounting officer; (3) every person who was 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. An expert is liable for misstatements or omissions only in the portion of the registration that she prepared or certified. Any defendant, other than the issuer (who has strict liability), may assert the defense of due diligence, which requires the defendant to show that he had reasonable grounds to believe and did believe that there were no untrue statements or material omissions. CASE 43-2 OMNICARE, INC. v. LABORERS DISTRICT COUNCIL CONSTRUCTION INDUSTRY PENSION FUND Supreme Court of the United States, 2015 575 U.S.____, 135 S.Ct. 1318, 191 L.Ed.2d 253 Kagan, J. Before a company may sell securities in interstate commerce, it must file a registration statement with the Securities and Exchange Commission (SEC). If that document either “contain[s] an untrue statement of a material fact” or “omit[s] to state a material fact ... necessary to make the statements therein not misleading,” a purchaser of the stock may sue for damages. [Citation.] This case requires us to decide how each of those phrases applies to statements of opinion. The Securities Act of 1933, [citation], protects invest¬ors by ensuring that companies issuing securities (known as “issuers”) make a “full and fair disclosure of information” relevant to a public offering. [Citation.] The linchpin of the Act is its registration requirement. With limited exceptions not relevant here, an issuer may offer securities to the public only after filing a registration statement. [Citation.] That statement must contain specified information about both the company itself and the security for sale. [Citation.] Beyond those required disclosures, the issuer may include additional representa¬tions of either fact or opinion. Section 11 of the Act promotes compliance with these disclosure provisions by giving purchasers a right of action against an issuer or designated individuals (directors, partners, underwriters, and so forth) for material misstatements or omissions in registration statements. * * * Section 11 thus creates two ways to hold issuers liable for the contents of a registration statement—one focusing on what the statement says and the other on what it leaves out. Either way, the buyer need not prove (as he must to establish certain other securities offenses) that the defendant acted with any intent to deceive or defraud. [Citation.] This case arises out of a registration statement that * * * Omnicare filed in connection with a public offering of common stock. Omnicare is the nation’s largest provider of pharmacy services for residents of nursing homes. Its registration statement contained (along with all mandated disclosures) analysis of the effects of various federal and state laws on its business model, including its acceptance of rebates from pharmaceutical manufacturers. [Citation.] Of significance here, two sentences in the registration statement expressed Omnicare’s view of its compliance with legal requirements: We believe our contract arrangements with other healthcare providers, our pharmaceutical suppliers and our pharmacy practices are in compliance with applicable federal and state laws. [Citation.] We believe that our contracts with pharmaceutical manufacturers are legally and economically valid arrangements that bring value to the healthcare system and the patients that we serve. [Citation.] Accompanying those legal opinions were some caveats. On the same page as the first statement above, Omnicare mentioned several state-initiated “enforcement actions against pharmaceutical manufacturers” for offering payments to pharmacies that dispensed their products; it then cautioned that the laws relating to that practice might “be interpreted in the future in a manner inconsistent with our interpretation and application.” [Citation.] And adjacent to the second statement, Omnicare noted that the Federal Government had expressed “significant concerns” about some manufacturers’ rebates to pharmacies and warned that business might suffer “if these price concessions were no longer provided.” [Citation.] * * * pension funds that purchased Omnicare stock in the public offering (hereinafter Funds), brought suit alleging that the company’s two opinion statements about legal compliance give rise to liability under §11. Citing lawsuits that the Federal Government later pressed against Omnicare, the Funds’ complaint maintained that the company’s receipt of payments from drug manufacturers violated anti-kickback laws. [Citation.] Accordingly, the complaint asserted, Omnicare made “materially false” representations about legal compliance. [Citation.] And so too, the complaint continued, the company “omitted to state [material] facts necessary” to make its representations not misleading. [Citation.] The Funds claimed that none of Omnicare’s officers and directors “possessed reasonable grounds” for thinking that the opinions offered were truthful and complete. [Citation.] * * * The District Court granted Omnicare’s motion to dismiss * * * [because] the Funds’ complaint failed to [claim] that “the company’s officers knew they were violating the law.” [Citation.] The Court of Appeals for the Sixth Circuit reversed. [Citation.] It acknowledged that the two statements highlighted in the Funds’ complaint expressed Omnicare’s “opinion” of legal compliance * * * But even so, the court held, the Funds had to allege only that the stated belief was “objectively false”; they did not need to contend that anyone at Omnicare “disbelieved [the opinion] at the time it was expressed.” [Citation.] We granted certiorari, [citation], to consider how §11 pertains to statements of opinion. * * * The Sixth Circuit held, and the Funds now urge, that a statement of opinion that is ultimately found incorrect—even if believed at the time made—may count as an “untrue statement of a material fact.” * * * But that argument wrongly conflates facts and opinions. A fact is “a thing done or existing” or “[a]n actual happening.” Webster’s New International Dictionary 782 (1927). An opin¬on is “a belief[,] a view,” or a “sentiment which the mind forms of persons or things.” [Citation.] Most important, a statement of fact (“the coffee is hot”) expresses certainty about a thing, whereas a statement of opinion (“I think the coffee is hot”) does not. * * * And Congress effectively incorporated just that distinction in §11’s first part by exposing issuers to liability not for “untrue statement[s]” full stop (which would have included ones of opinion), but only for “untrue statement[s] of ... fact.” [Citation.] *** That still leaves some room for §11’s false-statement provision to apply to expressions of opinion. As even Omnicare acknowledges, every such statement explicitly affirms one fact: that the speaker actually holds the stated belief. [Citations.] For that reason, [a] statement about product quality (“I believe our TVs have the highest resolution available on the market”) would be an untrue statement of fact—namely, the fact of her own belief—if she knew that her company’s TVs only placed second. And so too the statement about legal compliance (“I believe our marketing practices are lawful”) would falsely describe her own state of mind if she thought her company was breaking the law. * * * In addition, some sentences that begin with opinion words like “I believe” contain embedded statements of fact * * *. [Citation.] Suppose the CEO * * * said: “I believe our TVs have the highest resolution available because we use a patented technology to which our competitors do not have access.” That statement may be read to affirm not only the speaker’s state of mind, as described above, but also an underlying fact: that the company uses a patented technology. [Citation.] Accordingly, liability under §11’s false-statement provision would follow (once again, assuming materiality) not only if the speaker did not hold the belief she professed but also if the supporting fact she supplied were untrue. But the Funds cannot avail themselves of either of those ways of demonstrating liability. The two sentences to which the Funds object are pure statements of opin¬ion: To simplify their content only a bit, Omnicare said in each that “we believe we are obeying the law.” And the Funds do not contest that Omnicare’s opinion was honestly held. * * * What the Funds instead claim is that Omnicare’s belief turned out to be wrong—that whatever the company thought, it was in fact violating anti-kickback laws. But that allegation alone will not give rise to liability under §11’s first clause because, as we have shown, a sincere statement of pure opinion is not an “untrue statement of material fact,” regardless whether an investor can ultimately prove the belief wrong. That clause, limited as it is to factual statements, does not allow investors to second-guess inherently subjective and uncertain assessments. * * * That conclusion, however, does not end this case because the Funds also rely on §11’s omissions provi¬sion, alleging that Omnicare “omitted to state facts necessary” to make its opinion on legal compliance “not misleading.” [Citation.] As all parties accept, whether a statement is “misleading” depends on the perspective of a reasonable investor: The inquiry (like the one into materiality) is objective. [Citation.] We therefore must consider when, if ever, the omission of a fact can make a statement of opinion like Omnicare’s, even if literally accurate, misleading to an ordinary investor. *** * * * [A] reasonable investor may, depending on the circumstances, understand an opinion statement to convey facts about how the speaker has formed the opinion—or, otherwise put, about the speaker’s basis for holding that view. And if the real facts are otherwise, but not provided, the opinion statement will mislead its audience. Consider an unadorned statement of opinion about legal compliance: “We believe our conduct is lawful.” If the issuer makes that statement without having consulted a lawyer, it could be misleadingly incomplete. In the context of the securities market, an investor, though recognizing that legal opinions can prove wrong in the end, still likely expects such an assertion to rest on some meaningful legal inquiry—rather than, say, on mere intuition, however sincere. Similarly, if the issuer made the statement in the face of its lawyers’ contrary advice, or with knowledge that the Federal Government was taking the opposite view, the investor again has cause to complain: He expects not just that the issuer believes the opinion (however irrationally), but that it fairly aligns with the information in the issuer’s possession at the time. Thus, if a registration statement omits material facts about the issuer’s inquiry into or knowl¬edge concerning a statement of opinion, and if those facts conflict with what a reasonable investor would take from the statement itself, then §11’s omissions clause creates liability. An opinion statement, however, is not necessarily misleading when an issuer knows, but fails to disclose, some fact cutting the other way. Reasonable investors understand that opinions sometimes rest on a weighing of competing facts; indeed, the presence of such facts is one reason why an issuer may frame a statement as an opinion, thus conveying uncertainty. * * * * * * * * * Congress adopted §11 to ensure that issuers “tell[ ] the whole truth” to investors. [Citation.] For that reason, literal accuracy is not enough: An issuer must as well desist from misleading investors by saying one thing and holding back another. * * * That outcome would ill-fit Congress’s decision to establish a strict liability offense promoting “full and fair disclosure” of material information. [Citation.] * * * The decision Congress made, for the reasons we have indicated, was to extend §11 liability to all statements rendered misleading by omission. * * * Section 11’s omissions clause, as applied to statements of both opinion and fact, necessarily brings the reasonable person into the analysis, and asks what she would naturally understand a statement to convey beyond its literal meaning. And for expressions of opinion, that means considering the foundation she would expect an issuer to have before making the statement. * * * * * * As we have explained, an investor cannot state a claim by alleging only that an opinion was wrong; the complaint must as well call into question the issuer’s basis for offering the opinion. [Citation.] * * * To be specific: The investor must identify particular (and material) facts going to the basis for the issuer’s opinion—facts about the inquiry the issuer did or did not conduct or the knowledge it did or did not have—whose omission makes the opinion statement at issue misleading to a reasonable person reading the statement fairly and in context. [Citation.] That is no small task for an investor. [The judgment of the Court of Appeals is vacated, and the case is remanded for further proceedings.] 43-6c Antifraud Provision Rule 10b-5 of the 1934 Act applies to the issuance or sale of all securities, even those exempted by the 1933 Act. The 1933 Act also contains two antifraud provisions: Section 12(2) and Section 17(a). Section 12(A)(2) — imposes express liability on one who offers or sells a security by means of a prospectus or oral communication that contains an untrue statement of material fact or an omission of a material fact. 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. If the purchaser still owns the security, the seller is liable to the purchaser for the amount she paid on tender of the security. If the purchaser no longer owns the security, she may recover damages from the seller. Section 17(A) — prohibits devices, schemes or artifices to defraud, untrue statements or omissions of material facts, and transactions or business practices intended to defraud a purchaser. 43-6d Criminal Sanctions The 1933 Act imposes criminal sanctions on any person who willfully violates any of the provisions of the act or the rules and regulations promulgated by the SEC pursuant to the act. Conviction may carry a fine of not more than $10,000 or imprisonment of not more than 5 years, or both. Moreover, under the Federal Alternative Fines Act, if any person derives pecuniary gain from the offense, or if the offense results in pecuniary loss to a person other than the defendant, the defendant may be fined up to the greater of twice the gross gain or twice the gross loss. NOTE: See Fig. 43-3: Registration and Liability Provisions of the 1933 Act. THE SECURITIES EXCHANGE ACT OF 1934 The 1934 Act deals mainly with the resale of securities; it establishes rules for market operations and prohibits fraudulent and manipulative practices. *** Chapter Outcome *** List which provisions of the 1934 Act apply only to publicly held companies and which apply to all companies. As amended by the JOBS Act, it requires registration of all securities listed on national exchanges, as well as equity securities of companies (1) whose assets exceed $10 million and (2) whose equity securities include a class of equity securities held by either (a) two thousand or more persons or (b) five hundred or more persons who are not accredited investors. Issuers who must register such securities are also subject to the 1934 Act’s periodic reporting requirements, short-swing profits provision, tender offer provisions, and proxy solicitation provisions, as well as the internal control and recordkeeping requirements of the Foreign Corrupt Practices Act. Issuers of securities, whether registered under the 1934 Act or not, must comply with antifraud and antibribery provisions of the act. NOTE: See Figure 43-4: Applicability of the 1934 Act and Figure 43-5: Disclosure under the 1934 Act. 43-7 DISCLOSURE The 1934 Act requires the filing of securities registrations, periodic reports, disclosure statements for proxy solicitations, and disclosure statements for tender offers, as well as compliance with the accounting requirements imposed by the Foreign Corrupt Practices Act. In 1992 the SEC developed a new series of forms for qualifying issuers to use for registration and periodic reporting. Also in 1992, the SEC imposed new compensation disclosure rules designed to provide shareholders with annual and long-term compensation for senior executives. In addition, the issuer must inform the shareholders of their cumulative return over the previous five years and how that figure compares with the Standard and Poor's 500 Composite Stock Price Index and any recognized industry index. Effective in 2000, a plain English summary term sheet is required in all tender offers, mergers, and going private transactions. *** Chapter Outcome*** Explain the disclosure requirements of the 1934 Act. 43-7a Registration Requirements for Securities All regulated publicly held companies must register with the SEC. These one-time registrations apply to an entire class of securities. Thus, they differ from registrations under the 1933 Act, which relate only to securities in a specific offering. Registration requires disclosure of • the company’s organization, financial structure, and nature of the business; • the terms, positions, rights, and privileges of the different classes of outstanding securities; • the names of the directors, officers, and underwriters and each security holder owning more than 10 percent of any class of nonexempt equity security; • bonus and profit-sharing arrangements; and • balance sheets and profit-and-loss statements for the three preceding fiscal years. 43-7b Periodic Reporting Requirements After registration, an issuer must file annual (10-K) and periodic (10-Q and 8-K) reports to update information contained in the original registration. Also subject to the periodic reporting requirements are issuers who have filed a 1933 Act registration statement with respect to any security unless, in any subsequent year, the securities are held by fewer than three hundred persons. Effective in early 2010, the SEC adopted new requirements for disclosure of (1) the qualifications of directors and nominees for director, and the reasons why that person should serve as a director of the issuer; (2) any directorships held by each director and nominee at any time during the past five years at any public company or registered investment company; (3) the consideration of diversity in the process by which candidates for director are considered for nomination by an issuer’s nominating committee; (4) an issuer’s board leadership structure and the board’s role in the oversight of risk; (5) the aggregate grant date fair value of stock awards and option awards granted in the fiscal year computed in accordance with Financial Accounting Standards Board Accounting Standards; and (6) to the extent that risks arising from a issuer’s compensation policies and practices for employees are reasonably likely to have a material adverse effect on the issuer, discussion of the issuer’s compensation policies or practices as they relate to risk management and risk-taking incentives that can affect the issuer’s risk and management of that risk. The SEC has adopted rules under the Sarbanes-Oxley Act requiring an issuer’s CEO and CFO to certify the financial and other information contained in the issuer’s annual and quarterly reports. Moreover, the Act requires that each periodic report shall be accompanied by a written statement by the CEO and CFO of the issuer certifying that the periodic report fully complies with the requirements of the 1934 Act and that information contained in the periodic report fairly presents, in all material respects, the financial condition and results of operations of the issuer. A CEO or CFO who certifies while knowing that the report does not comply with the Act is subject to a fine of up to $1 million or imprisonment of up to ten years, or both. A CEO or CFO who willfully certifies a statement knowing it does not comply with the Act shall be fined up to $5 million or imprisoned up to twenty years, or both. The Sarbanes-Oxley Act requires that issuers disclose in plain English to the public on a rapid and current basis such additional important information concerning material changes in the financial condition or operations of the issuer. The Act, as amended by the Dodd-Frank Act, requires that each director, each officer, and any person who owns more than 10 percent of a registered equity security file reports with the SEC within ten days after he or she becomes such beneficial owner, director, or officer, or within such shorter time as the SEC may establish by rule. The 1934 Act also requires that each director, each officer, and any person who owns more than 10 percent of a registered equity security file reports with the SEC for any month during which changes in his ownership of such equity securities have occurred. The Sarbanes-Oxley Act requires that these reports be filed before the end of the second business day following the day on which the transaction was executed, unless the SEC establishes a different deadline. The 1934 Act also requires that these filings reporting changes in ownership be made electronically on EDGAR, that the SEC make them publicly available on its Internet site, and that the issuers make them available on their corporate Web sites, if they maintain one. 43-7c Proxy Solicitations A proxy is a writing signed by a shareholder authorizing a named person to vote her shares of stock at a specified shareholders’ meeting. The 1934 Act regulates proxy solicitation, so that shareholders have adequate information upon which to vote. Solicitation of a proxy is prohibited unless each person solicited has been furnished with a written proxy statement containing specified information. A solicitation includes any request for a proxy, any request not to execute a proxy, or any request to revoke a proxy. The SEC has issued comprehensive and detailed rules prescribing the solicitation process and the disclosure of information about the issuer. Proxy Statements — A proxy statement describes all material facts concerning the matters being submitted to security holders for a vote, together with a proxy form on which the security holders can indicate their approval or disapproval of each proposal. In an election of directors, proxy solicitations by a person other than the issuer are subject to similar disclosure requirements. The issuer in such an election also must include an annual report with the proxy statement. Effective in 2010, the SEC requires in proxy materials relating to election of directors that the issuer disclose the qualifications of nominees for director, and the reasons why that person should serve as a director of the issuer. The Dodd-Frank Act authorizes the SEC to issue rules requiring that an issuer’s proxy solicitation include nominations for the board of directors submitted by shareholders. Under the Dodd-Frank Act, the SEC must issue rules requiring issuers to disclose in annual proxy statements the reasons why, if the issuer has chosen to separate or combine the positions of chairman of the board of directors and CEO. The Dodd-Frank Act contains several provisions regarding executive compensation. First, at least once every three years, issuers must include a provision in certain proxy statements for a nonbinding shareholder vote on the compensation of executives. In a separate resolution, shareholders determine whether this “say on pay” vote should be held every one, two, or three years. Second, the SEC must issue rules requiring issuers to describe clearly in annual proxy statements information that shows the relationship between executive compensation actually paid and the financial performance of the issuer, taking into account any change in the value of the shares of stock and dividends of the issuer and any distributions. Third, the SEC must issue rules requiring the disclosure of (1) the median of the annual total compensation of all issuer’s employees except the CEO, (2) the annual total compensation of the CEO, and (3) the ratio of the amount described in (1) to the amount described in (2). The JOBS Act exempts EGCs from the requirement for separate shareholder approval of executive compensation, including golden parachute compensation. Effective March 30, 2007, the SEC amended its proxy rules to provide an alternative method for issuers and other persons to furnish proxy materials to shareholders: posting them on an Internet Web site and providing shareholders with notice of the availability of the proxy materials. Issuers must make paper or e-mail copies of the proxy materials available without charge to shareholders on request. Shareholder Proposals — Where management solicits proxies, any security holder entitled to vote has the opportunity to communicate with other security holders. On written request from the security holder, the corporation must mail the communication at the security holder’s expense or, at its option, promptly furnish to that security holder a current list of security holders. If an eligible security holder entitled to vote submits a timely proposal for action, management must include the proposal in its proxy statement along with a brief statement explaining the shareholder’s reason for making the proposal. Management may omit a shareholder’s proposal if, among other things, (1) under state law, it is not a proper subject for shareholder action; (2) would require the issuer to violate any laws; (3) it is beyond the issuer’s power to accomplish; , (4) it relates to the conduct of the ordinary business operations of the issuer, or (5) it relates to a nomination or an election for membership on the issuer’s board of directors or to a procedure for such nomination or election. 43-7d Tender Offers A tender offer is a general invitation to a company’s shareholders to purchase their shares at a specified price for a specified time. In 1968 Congress enacted the Williams Act, which amended the 1934 Act to extend reporting and disclosure requirements to tender offers and other block acquisitions. The purpose of the Williams Act is to provide public shareholders with full disclosure by both the bidder and the target company, so that shareholders may make an informed decision. Disclosure requirements — These apply to three situations: (1) when a person or group acquires more than 5 percent of a class of voting securities registered under the 1934 Act, (2) when a person makes a tender offer for more than 5 percent of a class of registered equity securities, or (3) when the issuer makes an offer to repurchase its own registered shares. A statement must be filed with the SEC containing: (1) the acquisitor’s background, (2) the source of funds used to acquire the securities, (3) the purpose of the acquisition, including any plans to liquidate the company or to make major changes in the corporate structure, (4) the number of shares owned, and (5) the terms of the transaction; and (6) any relevant contracts,. This disclosure is also required of anyone soliciting shareholders to accept or reject a tender offer. A copy of the statement must be furnished to each offeree and sent to the issuer. The target company has 10 days in which to respond to the bidder’s tender offer by (1) recommending acceptance or rejection, (2) expressing no opinion and remaining neutral, or (3) stating that it is unable to take a position. The target company’s response must include the reasons for the position it takes. Required Practices — The tender offer must be kept open for at least 20 business days. Shareholders who tender their shares may withdraw them at any time during the offering period. The tender offer must be open to all holders of the class of shares subject to the offer. All shares tendered must be purchased for the same price; if an offering price is increased, both those who have already tendered and those who have yet to tender will receive the benefit of the increase. A tender offeror who offers to purchase less than all of the outstanding securities of the target must accept, on a pro rata basis, securities tendered during the offer. During the tender offer, the bidder may buy shares of the target only through that tender offer. In a tender offer for all outstanding shares of a class, a tender offeror may provide a subsequent offering period of three to twenty days after completion of a tender offer, during which security holders can tender shares without withdrawal rights. Defensive Tactics — Confronted by an uninvited takeover bid — directly or potentially — the target company’s management may decide to oppose the bid or to seek to prevent it. A company may use defensive tactics to make the takeover very difficult or expensive. State Regulation — In the 1980s, when the availability of junk bonds vastly increased the number of attempted takeovers of public companies, state legislatures reacted with alarm. More than forty states have enacted statutes regulating tender offers, most of which protect the target company from an unwanted takeover. • Some statutes empower the state to review the merits of the offer or the adequacy of disclosure. • Many impose waiting periods. • They generally require disclosure more detailed than that required by the Williams Act, and many exempt tender offers supported by the target company’s management. • Some states have adopted fair price statutes, requiring the acquisitor to pay all shareholders the highest price paid to any shareholder. • Some prohibit transactions with an acquisitor for a specified period after a change in control, unless disinterested shareholders approve. 43-7e Foreign Corrupt Practices Act The FCPA was enacted by Congress in 1977 as an amendment to the 1934 Act, and the FCPA was itself amended in 1988 and 1998. Act (1) imposes internal control requirements upon issuers with securities registered under the 1934 Act and (2) prohibits all U.S. persons, and certain foreign issuers of securities, from bribing foreign governmental or political officials The FCPA requires accounting requirements (1) to assure that an issuers’ books accurately reflect financial transactions, (2) to protect the integrity of independent audits of financial statement, and (3) to promote the reliability of financial information required by the 1934 Act. The Foreign Corrupt Practices Act also prohibits all domestic concerns from bribing foreign governmental or political officials. (The FCPA was prompted by scandals involving U.S. companies paying bribes overseas.) More detail on the antibribery provisions follows later in the chapter. *** Chapter Outcome *** Explain the potential civil liabilities under the 1934 Act. 43-8 LIABILITY Sanctions under the 1934 Act include civil liability to injured investors and issuers, civil penalties, and criminal penalties. The 1995 Reform Act imposes the on a plaintiff burden of proving the act or omission caused the loss for which the plaintiff seeks damages. It also limits the damages (which are based on the market price of a security) which can be recovered under the 1934 Act. Thirdly, it provides a “safe harbor” from civil liability for certain “forward-looking statements” made by issuers. 43-8a Misleading Statements in Reports Section 18 imposes express civil liability on any person who makes or causes any false or misleading statement about any material fact in any application, report, document, or registration filed with the SEC under the 1934 Act. A person who bought or sold a security in reliance upon such false or misleading statement without knowledge of its falsity may recover. However, a person is not liable if she acted in good faith and did not know that the statement was false or misleading. 43-8b Short-Swing Profits Section 16(b) of the 1934 Act imposes express liability upon insiders — directors, officers, and any person owning more than 10 percent of the stock of a corporation listed on a national stock exchange or registered with the SEC — for all profits resulting from their “short-swing” trading in such stock. In that case, the corporation is entitled to recover any and all profit the insider realized on the transactions. Suits to recover can be brought by the issuer or by the owner of any security of the issuer, on behalf of and in the name of the issuer, if the issuer fails to bring suit within sixty days of the owner’s request. 43-8c Antifraud Provision Section 10(b) and SEC Rule 10b-5 make it unlawful for any person using 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 without which the information is misleading; or (4) to engage in any act, practice, or course of business that would operate as a fraud or deceit upon any person. Rule 10b-5 applies to any purchase or sale of any security, whether registered under the 1934 Act or not, whether publicly traded or closely held, whether listed on an exchange or sold over the counter, or whether part of an initial issuance or a secondary distribution. There are no exemptions. The implied liability under Rule 10b-5 applies to purchaser as well as seller misconduct and allows both defrauded sellers and buyers to recover. Requisites of Rule 10b-5 — Recovery of damages requires proof of (1) a misstatement or omission (2) that is material, (3) made with scienter (i.e., made knowingly), and (4) relied upon (5) in connection with the purchase or sale of a security. This rule differs from common law fraud in that Rule 10b-5 imposes an affirmative duty of disclosure. A misstatement or omission is material if a reasonable investor would be substantially likely to consider it important in deciding whether to buy or sell the security. Material facts include substantial changes in dividends or earnings, significant misstatements of asset value, and the fact that the issuer is about to become a target of a tender offer. In an action for damages under Rule 10b-5, it must be shown that the violation was committed with scienter, or intentional misconduct. Negligence is not sufficient. Remedies for Rule 10b-5 violations include rescission, damages, and injunctions. The courts are divided over the measure of damages. CASE 43-3 MATRIXX INITIATIVES, INC. v. SIRACUSANO Supreme Court of the United States, 2011 563 U.S. ___, 131 S.CT. 1309, 179 L.ED.2D 398 http://scholar.google.com/scholar_case?q=131+S.+Ct.+1309&hl=en&as_sdt=2,34&case=15831619199744263593&scilh=0 Sotomayor, J. [Matrixx develops, manufactures, and markets over-the-counter pharmaceutical products. Its core brand of products is called Zicam. All of the products sold under the Zicam name are used to treat the common cold and associated symptoms. At the time of the events in question, one of Matrixx’s products was Zicam Cold Remedy, which came in several forms including nasal spray and gel. The active ingredient in Zicam Cold Remedy was zinc gluconate. Respondents allege that Zicam Cold Remedy accounted for approximately 70 percent of Matrixx’s sales. Respondents initiated this securities fraud class action against Matrixx on behalf of individuals who purchased Matrixx securities between October 22, 2003, and February 6, 2004. The action principally arises out of statements that Matrixx made during that period relating to revenues and product safety. Respondents claim that Matrixx’s statements were misleading in light of reports that Matrixx had received, but did not disclose, about consumers who had lost their sense of smell (a condition called anosmia) after using Zicam Cold Remedy nasal spray or gel. On January 30, 2004, Dow Jones Newswires reported that the Food and Drug Administration (FDA) was “looking into complaints that an over-the-counter common-cold medicine manufactured by a unit of Matrixx Initiatives, Inc. (MTXX) may be causing some users to lose their sense of smell” in light of at least three product liability lawsuits. Matrixx’s stock fell from $13.55 to $11.97 per share after the report. In response, on February 2, Matrixx issued a press release: All Zicam products are manufactured and marketed according to FDA guidelines for homeopathic medicine. Our primary concern is the health and safety of our customers and the distribution of factual information about our products. Matrixx believes statements alleging that intranasal Zicam products caused anosmia (loss of smell) are completely unfounded and misleading. In no clinical trial of intranasal zinc gluconate gel products has there been a single report of lost or diminished olfactory function (sense of smell). Rather, the safety and efficacy of zinc gluconate for the treatment of symptoms related to the common cold have been well established in two double-blind, placebo-controlled, randomized clinical trials. In fact, in neither study were there any reports of anosmia related to the use of this compound. The overall incidence of adverse events associated with zinc gluconate was extremely low, with no statistically significant difference between the adverse event rates for the treated and placebo subsets. * * * The day after Matrixx issued this press release, its stock price rebounded to $13.40 per share. On February 19, 2004, Matrixx filed a Form 8-K with the SEC stating that it had “convened a two-day meeting of physicians and scientists to review current information on smell disorders” and that “[i]n the opinion of the panel, there is insufficient scientific evidence at this time to determine if zinc gluconate, when used as recommended, affects a person’s ability to smell.” Respondents claimed that Matrixx violated § 10(b) of the Securities Exchange Act and SEC Rule 10b-5 by making untrue statements of fact and failing to disclose material facts necessary to make the statements not misleading in an effort to maintain artificially high prices for Matrixx securities. Matrixx moved to dismiss respondents’ complaint. The District Court granted the motion to dismiss, holding that the respondents had not alleged a statistically significant correlation between the use of Zicam and anosmia so as to make failure to publicly disclose complaints and a medical study a material omission. The District Court also agreed that the respondents had not stated with particularity facts giving rise to a strong inference of scienter. The Court of Appeals reversed, holding that the District Court had erred in requiring an allegation of statistical significance to establish materiality. It concluded that the complaint adequately alleged “information regarding the possible link between Zicam and anosmia” that would have been significant to a reasonable investor. With respect to scienter, the Court of Appeals concluded that “[w]ithholding reports of adverse effects of and lawsuits concerning the product responsible for the company’s remarkable sales increase is ‘an extreme departure from the standards of ordinary care,’” giving rise to a strong inference of scienter.] Section 10(b) of the Securities Exchange Act makes it unlawful for any person to “use or employ, in connection with the purchase or sale of any security . . . any manipulative or deceptive device or contrivance in contravention of such rules and regulations as the Commission may prescribe as necessary or appropriate in the public interest or for the protection of investors.” [Citation.] SEC Rule 10b-5 implements this provision by making it unlawful to, among other things, “make any untrue statement of a material fact or to omit to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading.” [Citation.] We have implied a private cause of action from the text and purpose of § 10(b). [Citation.] To prevail on their claim that Matrixx made material misrepresentations or omissions in violation of § 10(b) and Rule 10b-5, respondents must prove “(1) a material misrepresentation or omission by the defendant; (2) scienter; (3) a connection between the misrepresentation or omission and the purchase or sale of a security; (4) reliance upon the misrepresentation or omission; (5) economic loss; and (6) loss causation.” [Citation.] * * * * * * To prevail on a § 10(b) claim, a plaintiff must show that the defendant made a statement that was “misleading as to a material fact.” Basic [Inc. v. Levinson, citation.] In Basic, we held that this materiality requirement is satisfied when there is “‘a substantial likelihood that the disclosure of the omitted fact would have been viewed by the reasonable investor as having significantly altered the “total mix” of information made available.’” [Citation.] * * * * * * We observed that “[a]ny approach that designates a single fact or occurrence as always determinative of an inherently fact-specific finding such as materiality, must necessarily be overinclusive or underinclusive.” * * * * * * Matrixx urges us to adopt a bright-line rule that reports of adverse events associated with a pharmaceutical company’s products cannot be material absent a sufficient number of such reports to establish a statistically significant risk that the product is in fact causing the events. * * * As in Basic, Matrixx’s categorical rule would “artificially exclud[e]” information that “would otherwise be considered significant to the trading decision of a reasonable investor.” [Citation.] Matrixx’s argument rests on the premise that statistical significance is the only reliable indication of causation. This premise is flawed: As the SEC points out, “medical researchers . . . consider multiple factors in assessing causation.” [Citation.] Statistically significant data are not always available. * * * A lack of statistically significant data does not mean that medical experts have no reliable basis for inferring a causal link between a drug and adverse events * * * It suffices to note that * * * “medical professionals and researchers do not limit the data they consider to the results of randomized clinical trials or to statistically significant evidence.” [Citation.] The FDA similarly does not limit the evidence it considers for purposes of assessing causation and taking regulatory action to statistically significant data. * * * It “does not apply any single metric for determining when additional inquiry or action is necessary, and it certainly does not insist upon ‘statistical significance.’” [Citation.] * * * Given that medical professionals and regulators act on the basis of evidence of causation that is not statistically significant, it stands to reason that in certain cases reasonable investors would as well. * * * As a result, assessing the materiality of adverse event reports is a “fact-specific” inquiry, [citation], that requires consideration of the source, content, and context of the reports. This is not to say that statistical significance (or the lack thereof) is irrelevant—only that it is not dispositive of every case. Application of Basic’s “total mix” standard does not mean that pharmaceutical manufacturers must disclose all reports of adverse events. * * * The fact that a user of a drug has suffered an adverse event, standing alone, does not mean that the drug caused that event. [Citation.] The question remains whether a reasonable investor would have viewed the nondisclosed information “‘as having significantly altered the “total mix” of information made available.’” For the reasons just stated, the mere existence of reports of adverse events—which says nothing in and of itself about whether the drug is causing the adverse events—will not satisfy this standard. [Citation.] Something more is needed, but that something more is not limited to statistical significance and can come from “the source, content, and context of the reports,” [citation]. This contextual inquiry may reveal in some cases that reasonable investors would have viewed reports of adverse events as material even though the reports did not provide statistically significant evidence of a causal link. Moreover, it bears emphasis that § 10(b) and Rule 10b-5(b) do not create an affirmative duty to disclose any and all material information. Disclosure is required under these provisions only when necessary “to make … statements made, in the light of the circumstances under which they were made, not misleading.” [Citations.] Even with respect to information that a reasonable investor might consider material, companies can control what they have to disclose under these provisions by controlling what they say to the market. Applying Basic’s “total mix” standard in this case, we conclude that respondents have adequately pleaded materiality. * * * * * * We believe that these allegations suffice to “raise a reasonable expectation that discovery will reveal evidence” satisfying the materiality requirement, [citation], and to “allo[w] the court to draw the reasonable inference that the defendant is liable for the misconduct alleged,” [citation]. The information provided to Matrixx by medical experts revealed a plausible causal relationship between Zicam Cold Remedy and anosmia. Consumers likely would have viewed the risk associated with Zicam (possible loss of smell) as substantially outweighing the benefit of using the product (alleviating cold symptoms), particularly in light of the existence of many alternative products on the market. Importantly, Zicam Cold Remedy allegedly accounted for 70 percent of Matrixx’s sales. Viewing the allegations of the complaint as a whole, the complaint alleges facts suggesting a significant risk to the commercial viability of Matrixx’s leading product. It is substantially likely that a reasonable investor would have viewed this information “‘as having significantly altered the “total mix” of information made available.’” Basic, [citation]. Matrixx told the market that revenues were going to rise 50 and then 80 percent. Assuming the complaint’s allegations to be true, however, Matrixx had information indicating a significant risk to its leading revenue-generating product. Matrixx also stated that reports indicating that Zicam caused anosmia were “‘completely unfounded and misleading’” and that “‘the safety and efficacy of zinc gluconate for the treatment of symptoms related to the common cold have been well established.’” [Citation.] Importantly, however, Matrixx had evidence of a biological link between Zicam’s key ingredient and anosmia, and it had not conducted any studies of its own to disprove that link. In fact, as Matrixx later revealed, the scientific evidence at that time was “‘insufficient … to determine if zinc gluconate, when used as recommended, affects a person’s ability to smell.’” [Citation.] Assuming the facts to be true, these were material facts “necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading.” [Rule 10b-5.] * * * Matrixx also argues that respondents failed to allege facts plausibly suggesting that it acted with the required level of scienter. “To establish liability under § 10(b) and Rule 10b-5, a private plaintiff must prove that the defendant acted with scienter, ‘a mental state embracing intent to deceive, manipulate, or defraud.’” [Citation.] We have not decided whether recklessness suffices to fulfill the scienter requirement. [Citation.] Because Matrixx does not challenge the Court of Appeals’ holding that the scienter requirement may be satisfied by a showing of “deliberate recklessness,” [citation], we assume, without deciding, that the standard applied by the Court of Appeals is sufficient to establish scienter. * * * These allegations, “taken collectively,” give rise to a “cogent and compelling” inference that Matrixx elected not to disclose the reports of adverse events not because it believed they were meaningless but because it understood their likely effect on the market. [Citation.] “[A] reasonable person” would deem the inference that Matrixx acted with deliberate recklessness (or even intent) “at least as compelling as any opposing inference one could draw from the facts alleged.” [Citation.] We conclude, in agreement with the Court of Appeals, that respondents have adequately pleaded scienter. Whether respondents can ultimately prove their allegations and establish scienter is an altogether different question. For the reasons stated, the judgment of the Court of Appeals for the Ninth Circuit is Affirmed. Insider Trading — Rule 10b-5 applies to sales or purchases by an “insider” who possesses material information that is unavailable to the general public. An insider who fails to disclose such information before trading on it will be liable unless he waits for the information to become public. Under new SEC Rule 10b5-1, a purchase or sale of an issuer’s security is based on material nonpublic information about that security or issuer if the person making the purchase or sale was aware of the information when the person entered into the transaction. Insiders, under Rule 10b-5, include directors, officers, employees, and agents of the security issuer as well as those with whom the issuer has entrusted information solely for corporate purposes, such as underwriters, accountants, lawyers, and consultants. In some instances, the rule also precludes people who receive material, nonpublic information from insiders — tippees — from trading on that information. New SEC Rule 10b5-2 adopts the misappropriation theory of liability: A violation includes the purchase or sale of a security on the basis of material nonpublic information in breach of trust or confidence that is owed to the issuer, the shareholders of that issuer or any other person who is the source of the material nonpublic information. Under new SEC Rule 10b5-2, a person has a duty of trust or confidence for purposes of the misappropriation theory of liability when: (1) a person agrees to maintain information in confidence; (2) two people have a history, pattern, or practice of sharing confidences such that the recipient of the information knows or reasonably should know that the person communicating the material nonpublic information expects that the recipient will maintain its confidentiality; or (3) a person receives or obtains material nonpublic information from his or her spouse, parent, child, or sibling. The Stop Trading on Congressional Knowledge Act of 2012 prohibits the purchase or sale of securities of any issuer by a person in possession of material nonpublic information regarding pending or prospective legislative action relating to the issuer of the securities if the information was obtained (1) by reason of being a member or employee of Congress or (2) knowingly from a member or employee of Congress. The Act also prohibits the purchase or sale of securities of any issuer by a person in possession of material nonpublic information derived from federal employment and relating to the issuer of the securities if the information was obtained (1) by reason of being a federal employee or (2) knowingly from a federal employee. Under new SEC Regulation FD, regulated issuers who disclose material nonpublic information to specified persons (primarily securities market professionals such as analysts and mutual fund managers) must make public disclosure of that information. If the selective disclosure was intentional or reckless, the issuer must make public disclosure simultaneously; for a non-intentional disclosure, the issuer must make public disclosure promptly, usually within 24 hours. . In 2013, the SEC issued a report (1) confirming that Regulation FD applies to social media and other emerging means of communication used by public companies the same way it applies to company websites and (2) clarifying that issuers can use social media outlets like Facebook and Twitter to announce key information in compliance with Regulation FD so long as investors have been alerted about which social media will be used to disseminate such information. With a few exceptions, Regulation FD does not apply to disclosures made in connection with securities offering registered under the 1933 Act. The SEC can enforce this rule by bringing an administrative action seeking a cease-and-desist order or a civil action seeking an injunction and/or civil money penalties. • Section 16(b) and Rule 10b-5 both address insider trading but differ in several respects. First, Section 16(b) applies only to transactions involving registered equity securities; Rule 10b-5 applies to all securities. • Second, Rule 10b-5 has a broader definition of insiders, including others besides directors, officers, and owners of more than 10% of the stock. • Third, Section 16(b) does not require that the insider possess material, nonpublic information; liability is strict. Rule 10b-5 applies to insider trading only where such information is not disclosed. • Fourth, Section 16(b) applies only to transactions within six months of each other; Rule 10b-5 has no such limitation. • Fifth, under Rule 10b-5, injured investors may recover damages on their own behalf; under Section 16(b), although shareholders may bring suit, any recovery is on behalf of the corporation. NOTE: See Figure 43-6: Parties Forbidden to Trade on Inside Information. CASE 43-4 UNITED STATES v. O’HAGAN Supreme Court of the United States, 1997 521 U.S. 642, 117 S.Ct. 2199, 138 L.Ed.2d 724 http://scholar.google.com/scholar_case?q=117+S.CT.+2199&hl=en&as_sdt=2,34&case=287189961484150105&scilh=0 Ginsburg, J. Respondent James Herman O’Hagan was a partner in the law firm of Dorsey & Whitney in Minneapolis, Minnesota. In July 1988, Grand Metropolitan PLC (Grand Met), a company based in London, England, retained Dorsey & Whitney as local counsel to represent Grand Met regarding a potential tender offer for the common stock of the Pillsbury Company, headquartered in Minneapolis. Both Grand Met and Dorsey & Whitney took precautions to protect the confidentiality of Grand Met’s tender offer plans. O’Hagan did no work on the Grand Met representation. Dorsey & Whitney withdrew from representing Grand Met on September 9, 1988. Less than a month later, on October 4, 1988, Grand Met publicly announced its tender offer for Pillsbury stock. On August 18, 1988, while Dorsey & Whitney was still representing Grand Met, O’Hagan began purchasing call options for Pillsbury stock. Each option gave him the right to purchase 100 shares of Pillsbury stock by a specified date in September 1988. Later in August and in September, O’Hagan made additional purchases of Pillsbury call options. By the end of September, he owned 2,500 unexpired Pillsbury options, apparently more than any other individual investor. [Citation.] O’Hagan also purchased, in September 1988, some 5,000 shares of Pills- bury common stock, at a price just under $39 per share. When Grand Met announced its tender offer in October, the price of Pillsbury stock rose to nearly $60 per share. O’Hagan then sold his Pillsbury call options and common stock, making a profit of more than $4.3 million. [The Securities and Exchange Commission initiated an investigation into O’Hagan’s transactions, culminating in an indictment alleging that O’Hagan defrauded his law firm and its client, Grand Met, by using for his own trading purposes material, nonpublic information regarding Grand Met’s planned tender offer in violation of §10(b) of the Securities Exchange Act of 1934 and SEC Rule 10b-5. A jury convicted O’Hagan and he was sentenced to a 41-month term of imprisonment. A divided panel of the Court of Appeals for the Eighth Circuit reversed O’Hagan’s conviction holding that liability under §10(b) and Rule 10b-5 may not be grounded on the “misappropriation theory” of securities fraud on which the prosecution relied.] We address * * * the Court of Appeals’ reversal of O’Hagan’s convictions under §10(b) and Rule 10b-5. Following the Fourth Circuit’s lead, see [citation], the Eighth Circuit rejected the misappropriation theory as a basis for § 10(b) liability. We hold, in accord with several other Courts of Appeals, that criminal liability under §10(b) may be predicated on the misappropriation theory. Under the “traditional” or “classical theory” of insider trading liability, §10(b) and Rule 10b-5 are violated when a corporate insider trades in the securities of his corporation on the basis of material, nonpublic information. Trading on such information qualifies as a “deceptive device” under §10(b), we have affirmed, because “a relationship of trust and confidence [exists] between the shareholders of a corporation and those insiders who have obtained confidential information by reason of their position with that corporation.” [Citation.] That relationship, we recognized, “gives rise to a duty to disclose [or to abstain from trading] because of the ‘necessity of preventing a corporate insider from * * * tak[ing] unfair advantage of * * * uninformed * * * stockholders.’” [Citation.] The classical theory applies not only to officers, directors, and other permanent insiders of a corporation, but also to attorneys, accountants, consultants, and others who temporarily become fiduciaries of a corporation. [Citation.] The “misappropriation theory” holds that a person commits fraud “in connection with” a securities transaction, and thereby violates §10(b) and Rule 10b-5, when he misappropriates confidential information for securities trading purposes, in breach of a duty owed to the source of the information. [Citation.] Under this theory, a fiduciary’s undisclosed, self-serving use of a principal’s information to purchase or sell securities, in breach of a duty of loyalty and confidentiality, defrauds the principal of the exclusive use of that information. In lieu of premising liability on a fiduciary relationship between company insider and purchaser or seller of the company’s stock, the misappropriation theory premises liability on a fiduciary-turned-trader’s deception of those who entrusted him with access to confidential information. The two theories are complementary, each addressing efforts to capitalize on nonpublic information through the purchase or sale of securities. The classical theory targets a corporate insider’s breach of duty to shareholders with whom the insider transacts; the misappropriation theory outlaws trading on the basis of nonpublic information by a corporate “outsider” in breach of a duty owed not to a trading party, but to the source of the information. The misappropriation theory is thus designed to “protec[t] the integrity of the securities markets against abuses by ‘outsiders’ to a corporation who have access to confidential information that will affect th[e] corporation’s security price when revealed, but who owe no fiduciary or other duty to that corporation’s shareholders.” [Citation.] In this case, the indictment alleged that O’Hagan, in breach of a duty of trust and confidence he owed to his law firm, Dorsey & Whitney, and to its client, Grand Met, traded on the basis of nonpublic information regarding Grand Met’s planned tender offer for Pillsbury common stock. [Citation.] This conduct, the Government charged, constituted a fraudulent device in connection with the purchase and sale of securities. [Court’s footnote: The Government could not have prosecuted O’Hagan under the classical theory, for O’Hagan was not an “insider” of Pillsbury, the corporation in whose stock he traded. * * *] We agree with the Government that misappropriation, as just defined, satisfies §10(b)’s requirement that chargeable conduct involve a “deceptive device or contrivance” used “in connection with” the purchase or sale of securities. We observe, first, that misappropriators, as the Government describes them, deal in deception. A fiduciary who “[pretends] loyalty to the principal while secretly converting the principal’s information for personal gain,” [citation], “dupes” or defrauds the principal. [Citation.] * * * * * * Because the deception essential to the misappropriation theory involves feigning fidelity to the source of information, if the fiduciary discloses to the source that he plans to trade on the nonpublic information, there is no “deceptive device” and thus no §10(b) violation—although the fiduciary-turned-trader may remain liable under state law for breach of a duty of loyalty. We turn next to the §10(b) requirement that the misappropriator’s deceptive use of information be “in connection with the purchase or sale of [a] security.” This element is satisfied because the fiduciary’s fraud is consummated, not when the fiduciary gains the confidential information, but when, without disclosure to his principal, he uses the information to purchase or sell securities. The securities transaction and the breach of duty thus coincide. This is so even though the person or entity defrauded is not the other party to the trade, but is, instead, the source of the nonpublic information. [Citation.] A misappropriator who trades on the basis of material, nonpublic information, in short, gains his advantageous market position through deception; he deceives the source of the information and simultaneously harms members of the investing public. [Citation.] * * * The misappropriation theory comports with §10(b)’s language, which requires deception “in connection with the purchase or sale of any security,” not deception of an identifiable purchaser or seller. The theory is also well-tuned to an animating purpose of the Exchange Act: to insure honest securities markets and thereby promote investor confidence. [Citation.] Although informational disparity is inevitable in the securities markets, investors likely would hesitate to venture their capital in a market where trading based on misappropriated nonpublic information is unchecked by law. An investor’s informational disadvantage vis-à-vis a misappropriator with material, nonpublic information stems from contrivance, not luck; it is a disadvantage that cannot be overcome with research or skill. [Citation.] In sum, considering the inhibiting impact on market participation of trading on misappropriated information, and the congressional purposes underlying §10(b), it makes scant sense to hold a lawyer like O’Hagan a §10(b) violator if he works for a law firm representing the target of a tender offer, but not if he works for a law firm representing the bidder. The text of the statute requires no such result. The misappropriation at issue here was properly made the subject of a §10(b) charge because it meets the statutory requirement that there be “deceptive” conduct “in connection with” securities transactions. * * * The judgment of the Court of Appeals for the Eighth Circuit is reversed, and the case is remanded for further proceedings consistent with this opinion. 43-8d Express Insider Trading Liability Section 20A imposes express civil liability on any person who buys or sells a security while in possession of material, nonpublic information. Any person who contemporaneously sold or purchased securities of the same class as those improperly traded may bring a private action against the trader to recover damages, not to exceed the profit gained or loss avoided by the violation, less any amount the violator disgorges to the SEC pursuant to a court order. The action must be brought within 5 years after the last transaction. Tippers are jointly and severally liable with tippees. 43-8e Civil Monetary Penalties for Insider Trading The SEC is authorized to have a civil penalty imposed upon any person who is involved in insider trading, including any person who directly or indirectly controlled a person who committed a violation. The trade must be on or through the facilities of a national securities exchange or from or through a broker or dealer. Purchases that are part of a public offering by an issuer are not included. The civil monetary penalty for a person who trades on inside information is determined by the court but may not exceed three times the profit gained or loss avoided. The maximum amount that may be imposed upon a controlling person is the greater of $1,525,000 (as adjusted for inflation in March 2013) or three times the profit gained or loss avoided. If the controlled person’s violation consists of tipping inside information, the controller’s liability is measured by the profit gained or loss avoided by the person to whom the controlled person directed the tip. Civil monetary penalties for insider trading are payable into the United States Treasury. The SEC is authorized to award bounties of up to 10% of a penalty to informants who helped lead to the imposition of the penalty. However, the Dodd-Frank Act has expanded whistleblower awards: the SEC now must award whistleblowers who voluntarily provide original information that leads to any successful enforcement action in which the SEC imposes monetary sanctions in excess of $1 million. The amount of the award must be between 10 percent and 30 percent of funds collected as monetary sanctions, as determined by the SEC. An action to recover a penalty must be brought within five years after the purchase or sale. 43-8f Misleading Proxy Statements Any person who distributes a materially false or misleading proxy statement may be liable to a shareholder who relies upon the statement in purchasing or selling and consequently suffers a loss. Material means there is a substantial likelihood that a reasonable shareholder would consider it important in deciding how to vote. Courts have held that negligence is sufficient for an action under the proxy rule’s antifraud provisions. If the proxy disclosure or filing requirement has been violated, a court may enjoin a shareholder meeting or any action taken at that meeting. Other remedies are rescission, damages, and attorney’s fees. 43-8g Fraudulent Tender Offers Section 14(e) makes it unlawful for any person to make any untrue statement of material fact, to omit any material fact, or to engage in fraudulent, deceptive, or manipulative practices in connection with a tender offer. Applies even if the target company is not subject to the 1934 Act’s reporting requirements. Some courts have implied civil liability for violations of Section 14(e). Because of the small number of cases, however, the requirements for such an action are not entirely clear. A target company may seek an injunction and a shareholder of the target may be able to recover damages or obtain rescission. The courts are likely to require scienter. CASE 43-5 SCHREIBER v. BURLINGTON NORTHERN, INC. Supreme Court of the United States, 1985 472 U.S. 1, 105 S.Ct. 2458, 86 L.Ed.2d 1 http://scholar.google.com/scholar_case?q=105+S.Ct.+2458&hl=en&as_sdt=2,34&case=1407924312497176128&scilh=0 Burger, C. J. On December 21, 1982, Burlington Northern, Inc., made a hostile tender offer for El Paso Gas Co. Through a wholly owned subsidiary, Burlington proposed to purchase 25.1 million El Paso shares at $24 per share. Burlington reserved the right to terminate the offer if any of several specified events occurred. El Paso management initially opposed the takeover, but its shareholders responded favorably, fully subscribing the offer by the December 30, 1982 deadline. Burlington did not accept those tendered shares; instead, after negotiations with El Paso management, Burlington announced on January 10, 1983, the terms of a new and friendly takeover agreement. Pursuant to the new agreement, Burlington undertook, inter alia, to (1) rescind the December tender offer, (2) purchase 4,166,667 shares from El Paso at $24 per share, (3) substitute a new tender offer for only 21 million shares at $24 per share, (4) provide procedural protections against a squeeze-out merger of the remaining El Paso shareholders, and (5) recognize “golden parachute” contracts between El Paso and four of its senior officers. By February 8, more than 40 million shares were tendered in response to Burlington’s January offer, and the takeover was completed. The rescission of the first tender offer caused a diminished payment to those shareholders who had tendered during the first offer. The January offer was greatly oversubscribed and consequently those shareholders who retendered were subject to substantial proration. Petitioner Barbara Schreiber filed suit on behalf of herself and similarly situated shareholders, alleging that Burlington, El Paso, and members of El Paso’s board violated §14(e)’s prohibition of “fraudulent, deceptive or manipulative acts or practices * * * in connection with any tender offer.” [Citation.] She claimed that Burlington’s withdrawal of the December tender offer coupled with the substitution of the January tender offer was a “manipulative” distortion of the market for El Paso stock. Schreiber also alleged that Burlington violated §14(e) by failing in the January offer to disclose the “golden parachutes” offered to four of El Paso’s managers. She claims that this January non-disclosure was a deceptive act forbidden by §14(e). The District Court dismissed the suit for failure to state a claim. * * * * * * We are asked in this case to interpret §14(e) of the Securities Exchange Act, [citation]. The starting point is the language of the statute. Section 14(e) provides: It shall be unlawful for any person to make any untrue statement of a material fact or omit to state any material fact necessary in order to make the statements made, in the light of the circumstances under which they are made, not misleading, or to engage in any fraudulent, deceptive or manipulative acts or practices, in connection with any tender offer or request or invitation for tenders, or any solicitation of security holders in opposition to or in favor of any such offer, request, or invitation. The Commission shall, for the purposes of this subsection, by rules and regulations define, and prescribe means reasonably designed to prevent, such acts and practices as are fraudulent, deceptive, or manipulative. [Citation.] * * Petitioner reads the phrase “fraudulent, deceptive or manipulative acts or practices” to include acts which, although fully disclosed, “artificially” affect the price of the takeover target’s stock. Petitioner’s interpretation relies on the belief that §14(e) is directed at purposes broader than providing full and true information to investors. Petitioner’s reading of the term “manipulative” conflicts with the normal meaning of the term. We have held in the context of an alleged violation of §10(b) of the Securities Exchange Act: Use of the word “manipulative” is especially significant. It is and was virtually a term of art when used in connection with the securities markets. It connotes intentional or willful conduct designed to deceive or defraud investors by controlling or artificially affecting the price of securities. Ernst & Ernst v. Hochfelder [see Chapter 44]. * * * The meaning the Court has given the term “manipulative” is consistent with the use of the term at common law, and with its traditional dictionary definition. * * * Our conclusion that “manipulative” acts under §14(e) require misrepresentation or nondisclosure is buttressed by the purpose and legislative history of the provision. Section 14(e) was originally added to the Securities Exchange Act as part of the Williams Act, [citation]. “The purpose of the Williams Act is to insure that public shareholders who are confronted by a cash tender offer for their stock will not be required to respond without adequate information.” [Citation.] * * * Nowhere in the legislative history is there the slightest suggestion that §14(e) serves any purpose other than disclosure, or that the term “manipulative” should be read as an invitation to the courts to oversee the substantive fairness of tender offers; the quality of any offer is a matter for the marketplace. * * * We hold that the term “manipulative” as used in §14(e) requires misrepresentation or nondisclosure. It connotes “conduct designed to deceive or defraud investors by controlling or artificially affecting the price of securities.” Ernst & Ernst v. Hochfelder [see Chapter 44]. Without misrepresentation or nondisclosure, §14(e) has not been violated. Applying that definition to this case, we hold that the actions of respondents were not manipulative. The amended complaint fails to allege that the cancellation of the first tender offer was accompanied by any misrepresentation, nondisclosure or deception. The District Court correctly found, “All activity of the defendants that could have conceivably affected the price of El Paso shares was done openly.” [Citation.] * * * The judgment of the Court of Appeals is affirmed. 43-8h Antibribery Provision of FCPA The Foreign Corrupt Practices Act enacted in the early 1970s makes it unlawful for any domestic concern or any of its officers, directors, employees, or agents to offer or give anything of value directly or indirectly to any foreign official, political party, or political official for the purpose of (1) influencing any act or decision of that person or party in his or its official capacity, (2) inducing an act or omission in violation of his or its lawful duty, or (3) inducing such person or party to use his or its influence to affect a decision of a foreign government in order to assist the domestic concern in obtaining or retaining business. An offer or promise of a prohibited payment is a violation even if the offer is not accepted or the promise is not performed. The 1988 amendments explicitly excluded routine governmental action not involving the discretion of the official, such as obtaining permits or processing applications. They also added an affirmative defense for payments that are lawful under the written laws or regulations of the foreign official’s country. Violations can result in fines of up to $2 million for corporations and other business entities; individuals may be fined a maximum of $100,000 or imprisoned up to 5 years, or both. Moreover, under the Federal Alternative Fines Act, the actual fine may be up to twice the benefit that the person sought to obtain by making the corrupt payment. Fines imposed upon individuals may not be paid directly or indirectly by the domestic concern on whose behalf they acted; the individuals must pay the fines themselves. In addition, civil monetary penalties up to $16,000 (as adjusted for inflation in March 2013) may be imposed. In 1997 the United States signed the Organisation for Economic Co-operation and Development Convention on Combating Bribery of Foreign Public Officials in International Business Transactions (OECD Convention). ). The OECD Convention has been adopted by at least forty nations. Since then, four additional nations have signed the treaty. In 1998 Congress enacted the International Anti-Bribery and Fair Competition Act of 1998 to conform the FCPA to the Convention. The 1998 Act expands the FCPA to include (1) payments made to “secure any improper advantage” from foreign officials, (2) all foreign persons who commit an act in furtherance of a foreign bribe while in the United States, and (3) officials of public international organizations within the definition of a “foreign official.” A public international organization is defined as either an organization designated by executive order pursuant to the International Organizations Immunities Act, or any other international organization designated by executive order of the president. 43-8i Criminal Sanctions Section 32 of the 1934 Act imposes criminal sanctions on any person who willfully violates any provision of the act (except the antibribery provision) or the rules and regulations promulgated by the SEC pursuant to the act. For individuals, conviction may carry a fine of not more than $1 million or imprisonment of not more than 10 years, or both, with one exception: a person who proves she had no knowledge of the rule or regulation is not subject to imprisonment. If the person, however, is not a natural person (for example, a corporation), a fine not exceeding $2.5 million may be imposed. Moreover, under the Federal Alternative Fines Act, if any person derives pecuniary gain from the offense, or if the offense results in pecuniary loss to a person other than the defendant, the defendant may be fined up to the greater of twice the gross gain or twice the gross loss. NOTE: See Figure 43-7: Civil Liability under the 1933 and 1934 Acts. Instructor Manual for Smith and Robersons Business Law Richard A. Mann, Barry S. Roberts 9781337094757, 9780357364000, 9780538473637
Close