SECUTIRIES LITIGATION
Prof. Winship, Fall 2015
CHAPTER 1. An Overview of Securities Litigation and Enforcement
INTRODUCTION
¾ Fundamental purpose of the securities laws: Philosophy of full disclosure
¾ History
o Prior to 1933, no federal regulation of the sales of securities
o 1929 through 1932: value of stocks sold on NYSE fell 80% in a long, slow, ugly decline
o Examples of very ugly practices in the sale of securities became front page news in early 1933
o The Pecora Hearings
¾ Securities Laws
o Securities Act of 1933
§ Regulates the offering and sale of new securities, e.g. IPO
§ Disclosure requirements:
· Transactional: Registration statement filed with SEC; prospectus distributed to investors
· Required in connection with any public sale of securities (unless an exemption applies)
o Securities Exchange Act of 1934
§ Regulates secondary market activity. Shares are already on the market.
§ Creates the SEC
§ Disclosure requirements:
· Periodic: Form 10-K (annual), Form 10-Q (quarterly), Form 8-K (episodic)
· Only required of reporting companies
o Amendments to these statutes
§ Williams Act, 1968: Tender offer regulation
· Tender offer: a publicized offer to buy shares of a publicly owned company ay an advertised price within a confined time period
§ PSLRA – Private Securities Litigation Reform Act of 1995: private securities actions restrictions; class action regulation
§ Sarbane-Oxley, 2002: post-Enron
§ Dodd-Frank, 2010: post-financial crisis
§ JOBS Act, 2012
¾ The Securities and Exchange Commission
o Independent agency. Not part of any department
o Enforces the securities laws
o Promulgates rules and regulations to implement those laws more effectively
¾ Definitions
o Security (def. under Securities Act § 2(a))
§ Specific instruments – stock, bond, etc.
§ General categories – investment contract, evidence of indebtness, etc.
o Reporting companies
§ Some securities law provisions apply only to reporting companies
§ Most publicly traded companies are reporting companies
§ Three categories:
· 1. Companies which have a class of securities listed on a national securities exchange.
· 2. Companies which have total assets exceeding $10 million and a class of equity securities held by at least 500 shareholders.
· 3. Companies that have filed a registration statement under the Securities Act that has become effective.
¾ Regulatory Goals of the Securities Laws
o Beginning goals:
§ Prevent manipulation and speculation
§ Full disclosure of all material information
§ Prevent fraud
§ Level playing field between insiders and investors
§ Congress rejected merits review: the law is not for the SEC to oversee whether the stock itself is good or not but rather to enforce disclosure of information of public companies.
o Today’s goals
§ All of the above +
§ Concerns with the efficiency of regulation have become more salient
§ Concerns with company’s access to capital have become more salient
§ Balance of interest between “investor protection” and “capital formation”
¾ Efficient Capital Markets Hypothesis (“ECMH”)
o Markets impound information – 3 versions
§ Weak: securities prices determined by currently available information rather than historical market trends
§ Semi-strong: once information becomes public, it is incorporated into the securities prices
§ Strong: even non-public information is impounded into security prices through leaks and insider trading
o Informationally efficient v. fundamentally efficient
§ Informationally efficient market: securities prices react quickly to new public information
§ Fundamentally efficient market: in addition, prices reflect the true value of the shares
CHAPTER 2 EXCHANGE ACT 10(b) and RULE 10b-5
¾ Exchange Act § 10(b)
It shall be unlawful for any person, directly or indirectly, by the use of any means or instrumentality of interstate commerce or of the mails, or of any facility of any national securities exchange –
(b) To use or employ, in connection with the purchase or sale of any security registered on national securities exchange or any security not so registered, 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.
¾ Rule 10b-5
It shall be unlawful for nay person, directly or indirectly, by the use of any means or instrumentality of interstate commerce, or of the mails or of any facility of any national securities exchange,
(a) To employ any device, scheme, or artifice to defraud,
(b) To make any untrue statement of a material facts 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, or
(c) To engage in any act, practice, or course of business which operates or would operate as a fraud or deceit upon any person.
in connection with the purchase or sale of any security.
¾ Enforcement
o Private action (upheld by the SCt in Superintendent of Ins. v. Bankers Life (1971))
§ To supplement the public actions
o Civil and administrative actions by the SEC
o Criminal action by the Department of Justice
¾ Interpretation of 10(b) and 10b-5
o Courts
§ The courts have been the principal interpreters of 10(b)
§ Policy: curbing frivolous suits
§ Developed Fraud-on-the-Market Doctrine based on ECMH: spares the plaintiffs the necessity of proving their individual reliance on the defendant’s fraud by allowing a presumption of reliance on the integrity of the market price (beneficial to Ps)
o PSLRA, which makes private actions more difficult
§ Heightened pleading requirements for private actionsàdismiss if not met under Section 21D(b)(3)(A)
§ Safe harbor for fraud involving forward-looking s
o Federalism: If the Court recognized breach of fiduciary duty as a cause of action under Section 10b-5, then federal courts would be ruling on corporate law issues which are traditionally covered by state law.
§ Santa Fe did not cross the line between federal and state, but starting with SOX, federalization creeps into traditional state corporate law
o Minority shareholders had the recourse to take action under the state corporate law, which was to challenge the appraisal
· The Federal-State Balance
o State law regulates
§ Shareholder liability
§ Corporate governance
§ Director/officer fiduciary duty
§ Shareholder rights and duties
o Federal law regulates
§ Disclosure of information by public companies
§ Fraud in connection with securities transactions
o SOX shifts balance, allowing federal statutes in
§ Proscribed transactions: CEO/CFO compensations, no loans to company officers
§ Procedures: annual internal control reports, code of ethics
§ Company structure: audit committee required with specified composition
Corporate Mismanagement and Lost State Remedies
¾ Elements of a Lost-State-Remedy case:
o 1) the lost state remedy and why it would have been available
o 2) how the undisclosed information would relate to the availability of the state remedy
o 3) how the undisclosed information would affect a reasonable shareholder’s decision to seek a state remedy
o 4) likelihood of success in getting the state remedy
GOLDBERG v. MERIDOR, 2d Cir.
· 10(b)’s deception requirement encompasses a breach by directors of their fiduciary duty to minority shareholders regarding an impending corporate transaction in the situation where the directors misstated or omitted certain material information and because of that deception, the minority shareholders lost the opportunity to enjoin the transaction under state law.
· Major distinction from Santa Fe: whether there was misstatement or omission of material information
· Minor distinction: minority shareholders had more remedies in state law than what the plaintiffs did in Santa Fe
HEALEY v. CATALYST RECOVERY OF PENNSYLVANIA, INC., 3d Cir. (1980)
· Holding: if the misrepresentation or omission by D prevents P from getting a state remedy, and if P can prove probable of success in state court, then he would have a 10b-5 cause of action in the federal court.
