Winship / Securities Litigation / Fall 2016
I. Introduction to the Securities Markets and Securities Regulation
A. US Securities Regulation
Securities Act 1933
Regulates primary market activity (eg. IPO)
It requires that any offer or sale of new securities be registered with the SEC pursuant to the 1933 Act, unless exempted from registration & prospectus liability
Disclosure
Transactional
Registration w/SEC
Prospectus distributed to new investors
Required in connection with any public sale of securities, unless exempted
Securities Exchange Act 1934
Regulates secondary market activity
Market where stock, bonds, options, and futures are bought and sold (eg. stock market)
Creates SEC
Independent agency
Enforces the securities laws
Promulgates rules and regulations to implement those laws more effectively
c. Disclosure
Periodic: issuers must regularly file company information with the SEC on certain forms, if the company has more than a certain number of shareholders and has a certain amount of assets (500 shareholders, above $10 million in assets, per Act sections 12, 13, and 15)
10-K; 10-Q; 8-K
Required only of reporting companies
Most publicly traded companies are reporting companies
Three categories
Companies which have a class of securities listed on a national securities exchange
Companies which have total assets exceeding $10 million and a class of equity securities held by at least 500 shareholders
Companies that have filed a registration statement under the Securities Act that has become effective
d. Contains antifraud provisions, 10b-5, which also covers insider trading
3) 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
Which makes private actions more difficult: Heightened pleading requirements for private actions. Dismiss if not met under Section 21D(b)(3)(A)
Safe harbor for fraud involving forward-looking statements
Class action regulation
Affirmative requirement of loss causation
Proportionate liability
Sarbane-Oxley, 2002: post-Enron
Lengthen the statute of limitations for private actions
Allowing the SEC to require “real time” disclosure rule for reporting companies
Dodd-Frank, 2010: post-financial crisis
Expanded SEC authority to sue aiders and abettors and controlling persons
JOBS Act, 2012
Cf. Courts interpret 10(b) and 10b-5
The courts have been the principal interpreters of 10(b)
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)
4) How does disclosure help?
Efficient Capital Markets Hypothesis (ECMH) – markets seize information / prices fully reflect all available info. Believe in rational markets. A direct implication is that it is impossible to “beat the market” consistently on a risk-adjusted basis since market prices should only react to new information or changes in discount rates
Fraud on the Market theory:
No need to show each investor actually saw the info incl misrepresentation; all we need to show is misrepresentation is included in the disclosed information
The theory is that other people (professional traders, mutual fund managers, securities analysts) did the reading, and that they made trades or recommendations that influenced the price.
Basic holds that reliance on the accuracy of the price can substitute for reliance on the accuracy of particular written or oral statements, when the statements affect the price-as they do for large and well-followed firms such as Baxter, for which there is a liquid public market.
This works only to the extent that markets efficiently reflect (and thus convey to investors the economic equivalent of) all public information.
(E&E p374) In cases of false or misleading representations on a public trading market (fraud on the market), courts have created a rebuttable presumption of reliance. Basic. It presumes that investors rely on the integrity of the stock’s market price so investors need not have seen misrepresentation. The theory is based on the hypothesis that, in an open and developed securities market, the price of a company’s stock is determined by the available material information regarding the company and its business. The Efficient Capital Market Hypothesis (ECMH) posits that in an efficient market, current prices always and fully reflect all relevant information about the commodities being traded. Assuming that material misinformation artificially distorts the market price, courts infer that investors have relied on the misinformation. This fraud on the market theory assumes that if the truth had been disclosed, investors would not have traded at the prevailing nondisclosure price.
Markets impound information – 3 forms; of ECMH:
Weak: securities prices determined by currently available info rather than historical market trends
Semi-strong: once info is public, it is incorporated into securities price; both that prices reflect all publicly available info and that prices instantly change to reflect new public information.
Strong: even non-public info is incorporated into price through leaks and insider trading; prices instantly reflect even hidden “insider” information
Prerequisites for hypothesis that misrepresentation impacts stock price
Stock traded in an efficient market
Misrepresentation is publicly known
Relevant transaction took place between the time of misrepresentation and when truth was revealed
B. Disclosure and Accuracy
Accuracy of Disclosure
EX Act encourages accurate disclosure thru internal and external mechanisms
EX Act requires mandatory disclosure for companies with securities listed on national securities exchange and later over-the-counter market
Antifraud liability deters company officials from providing materially inaccurate disclosures
EX Act requires companies to make and keep books, records and accounts that reasonably accurately reflect transactions and dispositions of the assets of the issuer. Sec 13(b)(2)(A)
Foreign Corrupt Practices Act (FCPA): illegal for companies and their supervisors to influence foreign officials with any personal payments or reward
Arguments favoring mandatory disclosure
Facilitates comparable disclosures by different companies
Reduces agency costs within firm
Overcomes an externality problem for firms disclosing information
Reduces duplicative research by professional investors and analysts
But who decides what to disclose? And who enforces? SEC’s mandatory disclosure vs. market’s ability to produce the optimal level of disclosure
What is a public company?
Public Company Status – Exchange Act
First – applied to listing on a national exchange (§ 12(a))
12(a) prohibits transactions on a national securities exchange unless a registration is effective for that security.
Process for registration is set forth in 12(b)
Then extended to Over the counter stocks (§ 12(g)(1)(A)
Not listed on a national securities exchange or completed a public offering under Securities Act
For registration requirements with SEC – Set the threshold level of assets/number of holders for over the counter stocks
“total assets” exceeding $10 million and
Class of equity securities held by at least 2,000 SHs (or 500 persons who are not accredited investors)
Filing a registration statement under the Securities Act (§ 15(d))
Broadened the category of public company, which requires companies registering securities for sale in a public offering under the Securities Act to comply with periodic disclosure requirements of Exchange Act at least until the next fiscal year after effective date
Makes private placement more attractive
rences Item 410 Reg S-X for biographical info on the top mgmt. and directors of an issuer
Item 410 Reg S-X: https://www.law.cornell.edu/cfr/text/17/229.401
Schedule 14A (requirements for proxy statement)
Proxy stmt: SEC requires that shareholders of a company whose securities are registered under Section 12 of the Securities Exchange Act of 1934 receive a proxy statement prior to a shareholder meeting, whether an annual or special meeting. Must disclose all important facts about the issues on which SHs vote
Hypo – Fluor gets a $1 billion contract for engineering work from X and K depends on X’s ability to secure financing from French IB. X asked not to disclose it. Rumors start to circulate that Fluor has entered in to K and stock prices went up. Fluora has a duty to disclose existence of K?
When to file 8-K?
Unless otherwise specified, a report is to be filed or furnished within four business days after occurrence of the event.
8K analysis (CB170)
Item 1: Registrant’s Business & operations
Item 1.01 requires the disclosure of material definitive agreements entered into (material amendment to or termination of) by a company that are not made in the ordinary course of business. The item parallels Items 601(b)(10) of Regulation S-K.
Only material definitive agreements need to be disclosed
Materiality: met the definition of materiality under Basic
General standard of materiality?
“ An omitted fact is material if there is a substantial likelihood that a reasonable shareholder would consider it important in deciding how to vote.”
“[T]here must be 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. TSC Indus., Inc. Adopted by Basic for purposes of Rule 10b-5
Uncertain and contingent facts
Probability/magnitude
Also eliminated the requirement that companies disclose their entry into non- binding agreements from this item.
Fluora case:
How ordinary K is?
Materiality of information?
Whether investment bankers in France is credible? – to figure out uncertainty and probability
Actual case: no duty to disclose this information probably based on Item 1.01
Item 2: Financial information (not covered in class)
Requires disclosure of material impairments to assets such as goodwill
Eg. Goodwill put on the book in connection with acquisition has dropped. It would mean the acquisition turned out to be unsuccessful
Item 3: Securities & trading markets (not covered in class)
Delisting or transfer of listing may signal lower liquidity for that stock in the future
Sale of unregistered securities result in dilution of interests of current SHs
Item 4: Matters related to accountants & financial statements (not covered in class)
Change in the company’s outside auditor may signal disagreements with auditors over accounting practices
