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Securities Regulation
University of San Diego School of Law
Lee, Mark R.

 
Subject: Securities Regulation
Professor: Mark Lee
Semester: Fall 2014
 
Note: The professor's exam is largely based upon the arguments he elicits during in class discussions. Accordingly, a significant portion of this outline consists of descriptions of in class discussions.
 
 
THE MARKET FOR CAPITAL AND FOR INFORMATION ABOUT THE VALUE OF INVESTMENTS
 
 
•   Investors seek the greatest return for the risk they are willing to put up with. 
 
•   Why would a corporation want/not want to disclose information?
◦                   1) Best interest of share holders
▪                                   Will disclose up to the point where the marginal benefits to shareholders exceed or equal the marginal cost of producing an disseminating the info.
▪                                   Benefits:
▪                                                   1) Cost of producing info is less to the corporation than it is to potential and present investors. Greater the cost for investors to obtain info the less they're willing to pay for a share. 
▪                                                                   The fact that companies produced financial statements long before they were required is consistent w/ theory. 
▪                                                   2) CPA audit avoids cost of investor's beliefs that resources will be misused
▪                                                   3) Nondisclosure implies you have something to hide. 
▪                                   Burden: 
▪                                                   Cost or production, threat of lawsuits, action by competitors. 
◦                   2) Benefit themselves only (would defraud and mislead) 
▪                                   Financial statements aren't very accurate (manager expects order in next year: sales expenses overstated – effort investment understated)
▪                                   FS are an efficient vehicle to defraud investors. Investors estimate future cash flows. FS are about the past. Tips and rumors would be better. 
▪                                   You have to suborn a CPA. And you also face criminal penalties. 
◦                   Takeaway: there are several factors that motivate managers to disclose unbiased, non fraudulent info. the more investors there are the more likely it's cost effective to publish info. 
SECURITES REGULATION: The nature of the law and its historical background
•   “Gaps” in Protection under the Common Law of Deceit – Bug or Feature?
◦                   Even if there were know CL of deceit, investors would want to signal their veracity to increase the price they can charge. on the other hand, the threat of liability for deceit is costly, particularly if there's a large potential class of P's. May be why P has so many roadblocks to recovery. 
◦                   Barrier 1: must prove a misrepresentation, not a mere failure to disclose
▪                                   Why? It's hard to say with certainty what someone must say 
◦                   Barrier 2: must prove a misrepresentation of fact, not merely of opinion
▪                                   Why? each party can exercise their judgement as well as the other. 
▪                                   Do the statements purport to speak in exact terms?
▪                                   Are the statements about things that each party can estimate as well as the other? If not, should the difference matter?
◦                   Barrier 3: P must prove reliance
▪                                   How do you go about proving reliance?
◦                   Barrier 4 D must have had knowledge of falsity, or at least lack of honest belief in the truth of the statement
▪                                   Liability for neg. mis. rep. has been recognized in limited circumstances. 
▪                                   Liability for deceit has been recognized where the D made affirmative statements purportedly out of his own knowledge without having a basis for it. 
◦                   Barrier 5: mis. rep must have been directed at P
▪                                   Many courts have realized this barrier to permit suit by 3rd parties whose reliance was to be expected. 
•   Antecedents
◦                   England and individual states had disclosure laws but they were usually poorly enforced. 
•   The Great Crash
◦                   The precipitating cause of the 1933 act was the 1929 stock market crash
◦                   Practices which (proponents of the act claimed) caused the debacle:
▪                                   Goldman Sachs grew quickly largely as a result of investing in themselves
•   The Passage of the 1933 Act
◦                   Only requires disclosure of facts regarding the securities sold, not what types of securities may be sold. 
◦                   Disclosure required by the act would not have prevented much of the speculative behavior that lead to the crash 
◦                   Real purposes of the act:
▪                                   1) Prevention of excesses of fraudulent transactions which will be deterred merely by the requirement that their details be revealed
▪                                   2) Placing a body of facts in the market during the early life of a security which will tend to produce more accurate appraisal of the worth of the security if it commands a brought enough market 
◦                   There's a lot of inherent risk in investing and if things go bad people will want to go after the people who did well. That's why the biz community wants limited liability for those responsible for disclosures. on the other hand, legislatures say that w/o strict penalties fraudulent behavior won't be deterred. 
•   Developments Since 1933
◦                   The 1934 Act
◦                   The SEC has “glossed” the statute through rules, changes of interpretation, no action letters, and administrative proceeding opinions
•   Not a Pretty Sight 
◦                   The act is super confusing. Constantly refers to different paraphrase
RULE 10B-5 LIABILITY 
 
 
Language: 
Rule 10b-5: Employment of Manipulative and Deceptive Practices”:
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,
(a) To employ any device, scheme, or artifice to defraud,
(b) To 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, 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.”
In the case of TSC Industries, Inc. v. Northway, Inc.,[2

icers, employees or were closely tied to employees of Texas Gulf. Texas Gulf, utilizing a geological survey, was conducting mining exploration in Canada. One area, called Kidd 55, was deemed promising by the survey, and a hole was drilled with the resulting core analyzed. The analysis showed that the minerals present in the area were extremely rich in minerals. Several other samples verified the findings. Defendants did not disclose the results of the analysis to outsiders, including other officers of Texas Gulf. Defendants did proceed to purchase shares and calls once they knew about the results. The trading activity and sample drilling did prompt rumors in the industry of a significant find by Texas Gulf, and on April 12, 1964 Defendants sent out a misleading press release to calm the speculation. The press release misrepresented the actual results of the samples. Defendants decided to announce the results on April 15, although the news did not re
ach the public until April 16. Defendants still traded between April 12 and the announcement. Defendants claimed that the information was not material to the value of the company and therefore did not feel obligated to publicly disclose the information. They also argued that any trading after they released the news at midnight of April 16 was legitimate because technically the news was disseminated to the public.
Resolution
•   

Questions of Law
•   Did the issuance of the April 12 Release Violate 10b-5?
•   Is not-yet-publically-disclosed information about the success of a drilling discovery material inside information invoking the insider trading responsibilities of Rule 10b-5?
Answer
•   Yes, the release was issued in a manner reasonably calculated to affect the market price of TGS stock and to influence the investing public. Therefore they were acting on insider information when they purchased their shares and calls on Texas Gulf stock.  
•   Remanded to decide whether the release was misleading to the reasonable investor and, if so, whether the court in its discretion should issue the injunction that the SEC seeks. 
According to court, why did they answer that way?
•   They purchased a great deal of shares in Texas Gulf, they deliberately kept the information from others, and the timing of their purchases occurred during the period that they exclusively held the information. It did not matter that there was still an element of uncertainty in the eventual mineral mining, but the key element was whether a reasonable person would believe that the information would be relevant to the price of the stock. Further, Defendants should not act upon the information until the information is disseminated to the point that the public would have had a reasonable opportunity to act on it.