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Securities Regulation
Rutgers University, Newark School of Law
Garten, Helen A.

Securities Regulation Outline – Garten – Spring 2011


1. Information is material if –

a. Substantial likelihood that disclosure

b. Would have been viewed by reasonable investor

c. As having significantly altered the “total mix” of information available.

2. SEC Bulletin: Factors that render a QUANTITATIVE misstatement in financial statement material (P. 61)

a. Item a precise measurement or estimate

b. Whether misstatement masks change in earnings or other trends

c. Whether misstatement hides a failure to meet analysts’ consensus expectations

d. Whether misstatement changes loss into income or vice versa, etc.

3. Forward – looking information

a. Basic Inc. v. Levinson (USSC)

i. Facts – Combustion Group wanted to acquire Basic Inc. Basic made 3 public statements denying it engaged in merger acquisition. Investors sold shares prior to the merger relying on this statement. Basic argued that statements made were NOT material bc at the time they were made the merger was not certain and contingent.

ii. Holding – Court says not going to exclude merger discussions when analyzing materiality. Can be significant to trading decision of reasonable investor. Whether merger discussions material depends on the facts.

1. To assess probability that merger will occur/materiality – look at indicia of interest in transaction at highest corporate levels. Board resolutions, instructions to investment bankers, and actual negotiations may serve as indicia of interest.

4. Historical Facts

a. Ganino v. Citizens Utility Co.

i. Citizens entered into K w/ Hungarian Telephone Co where it would make/ guarantee loans to it. Citizens in return would receive fees, consisting of mostly Hungarian stock & options. Ps, who were stockholders, and alleged that Citizens made material misrepresentations when it reported the $10M revenue as a 1996 1st and 2nd quarter income when it was actually 1995 revenue.

ii. Holding – P satisfies materiality requirement during pleading stage – alleges statement/omission that reasonable investor would have considered significant in making investment decision. Materiality depends on all relevant circumstances of particular case.

b. In re Merck & Co. Inc. Securities Litigation

i. Facts – Merck planned IPO of subsidiary Medco. Medco was pharmacy benefits manager which helped customers by reducing prices of drugs. The customers would make co-payments directly to pharmacy. Medco recognized these co-payments as revenue, which increased the revenue. This was inappropriate recognition of revenue from accounting standpoint. Merck’s stock price fell as a result of this disclosure in S-1 filing. Merck cancelled IPO and shareholders sued. Issue was whether this misstatement was material.

ii. Holding – Court measures post hoc the materiality of disclosed information by looking to the movement in the period immediately following disclosure, of the firm’s stock. Here, not material. No negative effect on Merck’s stock after disclosure. Generally measure materiality after first disclosure, but here no change when WSJ article disclosed this info.

5. The “Total Mix”

a. Truth on the market defense

i. Longman v. Food Lion, Inc.

1. Facts – Ps alleged that Food Lion misled the market and failed to disclose that its earnings during the 2 ½ year period were artificially inflated due to its misrepresentations about and failure to disclose widespread violations of federal labor laws and unsanitary food handling practices. After a primetime segment of these practices, prices of Food Lion stock fell by 11%.

2. Holding – Court holds that primetime did not bring anything new that wasn’t already known. Public statement s were just “puffery”. Unsanitary conditions were just isolated incidents and co was remedying problem, and Food Lion not required to make public statements about the existence of various sanitation problems.

6. Regulation S-K

a. Item 101

i. Description of Business

ii. Financial info about industry segments

iii. Narrative description of business

b. Item 102

i. Description of Property

c. Item 103

i. Disclose MATERIAL pending legal proceedings

1. NOT ordinary routine litigation incidental to business. BUT how do you determine this? Measure based on magnitude or probability?

ii. Description of the factual basis alleged

d. Management Integrity (Subpart 400)

i. Item 401 – provides for biographical info on directors and officers, including business experience for the past 5 years.

1. If criminal investigation has led to formal indictment during previous 5 years, disclosure is specifically required.

2. Disclosure is required if officer/director has been found by court or SEC to have violated the securities laws.

3. Disclosure is also required if officer or director filed for bankruptcy or if he served as an executive officer of a co. that filed for Bk.

4. No requirement that unadjudicated civil cases against officers/directors be disclosed. BUT may still be required if substantially reflects management integrity.

5. Lawsuits involving a wrongful benefit to a director or officer may be required to be disclosed as omission of a material fact, even if they have yet NOT been adjudicated. BUT may NOT be required to disclose if does not undercut fitness to serve.

ii. Item 402 – requires disclosure of executive compensation (including stock options).

iii. Item 403

1. Security ownership of certain beneficial owners

a. List any person known to registrant to be more than 5% owner.

b. Important bc this is change in control.

iv. Item 404 – disclosures for transactions b/w the issuer and certain related parties, including the family members of any director or officer.

1. Requires disclosure of transactions in excess of $120K b/w the issuer and directors, officers, 5% stockholders and family members of nay of those classes.

v. Item 408 – On top of expressly required info to be included in registration statement, there shall be added such further MATERIAL info as may be necessary to make the required statements in light of the circumstances under which they were made Not misleading.

vi. §402 Sarbanes-Oxley Act: prohibits loans by public companies to their executive officers and directors.

e. In the Matter of Franchard Corporation

i. SEC admin proceeding of whether to issue stop order to prevent an issuer from selling securities. There were essential deficiencies in Franchard’s registration statement regarding Glickman, a control person.

to pledge/hypothecate; (4) voting rights; (5) able to appreciate in value. Here, purchaser was not attracted by prospects of return. Purchaser wanted a place to live. So NOT investment for profit. Tax deduction was not considered a profit, nor was low rent. Federal securities law does NOT apply.

b. Form that Profits Take

i. SEC v. Edwards

1. Fact – ETS Payphones sold payphones to public. There was a 5-yr leaseback, management, and buyback agreement. Purchase price was $7K, purchasers received $82/month, and 14% annual return. Payphone did not generate revenue and co. filed for BK.

2. Issue: was it investment K if offered fixed return?

3. Holding – fixed return does not foreclose expectation of profits. No need to distinguish profits of fixed return v. variable return. There is expectation for profits. There is commonality bc one payphone has to make sufficient amt for investors to make some return.

5. Solely from the Efforts of the Promoter or A Third Party

a. Limited Partnership Interests: Presumed to be securities UNLESS limited partners exercise effective control over the enterprise.

i. General partner – liability lies here.

ii. Limited partner – liability limited to amt in their capital accts.

b. SEC v. Merchant Capital, LLC.

i. Facts – Merchant was in business of buying, collecting, reselling charged off consumer debt from financial institutions (ie banks/credit card co). Merchant began raising money by soliciting general public to become partners. Merchant was sole business of contact for all partners. Merchant entered into sales K w/ New Vision.

ii. Issue – were partners led to expect profits solely from efforts of Merchant?

iii. Holding –

1. General partners – fails “through the efforts of others” prong bc using their effort and skills. So don’t need protection of securities law.

2. Limited partners – may well have protection of securities law.

a. Look at following factors –

i. Did agreement divest limited partners of any meaningful conduct in business? If had meaningful conduct then fails Howey test. Here, limited partners only presented w/ one nominee and could only remove if unanimous vote.

ii. Limited partner’s experience and knowledge

1. Here general public had no experience in particular business. Court looks at relevant knowledge/experience SPECIFICALLY in debt collection.

iii. Meaningful partnership/venture powers

1. Don’t have that here either. Even if partners could have removed Merchant as manager, no realistic alternative bc debt pools were in fractional form w/ companies who only had contractual relationship w/ Merchant.