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Business Organizations Outline 7 - Securities, Materiality, Hypo, Study notes of Commercial Law

University of Florida (UF)Commercial Law

Business Organizations Outline for Law School. Exam guide for Business Organizations at the University of Florida Levin College of Law specifically. In this section: Securities, Materiality, Hypo

Typology: Study notes

2011/2012

Uploaded on 04/27/2012

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Business'Organizations'Outline'
' ' us.docsity.com'
Chapter(6!!Securities"
• First,'you'need'to'know'whether'or'not'a'particular'type'of'instrument'or'investment'will'
be'deemed'a'security'b/c:'
o It'tells'you'whether'the'registration'requirements'of'the'Securities'Act'apply'to'the'
transaction'and'
o And'in'general,'plaintiffs'have'a'much'easier'time'when'they'bring'suit'under'the'
securities'laws'than'they'would'if'they'had'to'bring'suit'under'state'common'law'fraud'
rules'
§ Elements'of'federal'securities'fraud'are'easier'to'prove''
§ Procedural'advantages'
• Definition'of'a'Security'under'the'Security'Act'(two'broad'categories):'
o Specificà'stock,'notes'and'bonds'
o Generalà'evidence'of'indebtedness,'investment'contracts,'any'instrument'commonly'
known'as'a'‘security’'
o Escape'hatch:'unless'the'context'otherwise'provides'(Monopoly'example)'
• State'laws'governing'securities'are'called'“blue'sky'rules”'
'
• Federal'Securities'Law'generally'deal'with'disclosure'and'IPOsF'
o Two'main'laws:'
§ Federal'Securities'Act'of'1933N'initial'offerings'
• 2'main'purposes:''
o Mandate'disclosure'of'material'information'for'the'public'
o Prevent'fraud'in'the'securities'market'
§ Securities'Act'of'1934N'principally'concerned'with'secondary/market'(securities'
are'already'out'in'the'market'and'people'are'selling'and'trading'them)'
• Proxy'solicitations'
• Share'purchases'and'tender'offers'
• Securities'fraud'(insider'trading)'
• Created'the'SEC'
• Allows'promulgation'of'rules'and'regulations'to'implement'these'
principles'
'
• Key'Assumptions'in'Competitive'MarketF'
o You'have'rational'actors'who'want'utility'maximization'
§ The'market'is'not'really'perfectly'rational'(because'there'is'a'deep'seeded'sense'
of'what'is'fair/not'fair)'
o There'is'perfect'market'information'(all'participants'in'the'market'know'and'can'access'
the'same'information)'
o No'dominant'players'in'the'market'
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Download Business Organizations Outline 7 - Securities, Materiality, Hypo and more Study notes Commercial Law in PDF only on Docsity!

Chapter 6 -­‐ Securities

  • First, you need to know whether or not a particular type of instrument or investment will be deemed a security b/c: o It tells you whether the registration requirements of the Securities Act apply to the transaction and o And in general, plaintiffs have a much easier time when they bring suit under the securities laws than they would if they had to bring suit under state common law fraud rules § Elements of federal securities fraud are easier to prove § Procedural advantages
  • Definition of a Security under the Security Act (two broad categories): o Specificà stock, notes and bonds o Generalà evidence of indebtedness, investment contracts, any instrument commonly known as a ‘security’ o Escape hatch: unless the context otherwise provides (Monopoly example)
  • State laws governing securities are called “blue sky rules”
  • Federal Securities Law generally deal with disclosure and IPOs-­‐ o Two main laws: § Federal Securities Act of 1933-­‐ initial offerings - 2 main purposes: o Mandate disclosure of material information for the public o Prevent fraud in the securities market § Securities Act of 1934-­‐ principally concerned with secondary market (securities are already out in the market and people are selling and trading them) - Proxy solicitations - Share purchases and tender offers - Securities fraud (insider trading) - Created the SEC - Allows promulgation of rules and regulations to implement these principles
  • Key Assumptions in Competitive Market-­‐ o You have rational actors who want utility maximization § The market is not really perfectly rational (because there is a deep seeded sense of what is fair/not fair) o There is perfect market information (all participants in the market know and can access the same information) o No dominant players in the market

o No barriers to exit/entry o Corporate/Securities law tries to fulfill these assumptions Robinson v. Glynn Facts:

  • Robinson sued Glynn alleging he committed federal securities fraud when he sold Robinson a partial interest in GeoPhone Company o Robinson loaned money to Glynn for field test and pledged to invest if test indicated CAMA worked o G told R that field test was a success (even though they did not use CAMA) o They entered into an operating agreementàR got shares, appointed 2 of 7 person board of managers, was vested with management based on ownership share Findings:
  • To establish a claim, R must prove fraud in connection with the purchase of securitiesà o R argues his membership interest qualifies as either an “investment contract” or “stock” o Investment contract (“catchall,” things that do not fit into stock or bondà (Howey Test) )a contract, transaction or scheme whereby a person invests his money in a common enterprise and is left to expect profits solely from the efforts of the promoter or third party § The question is whether an investor, as a result of the investment agreement itself or the factual circumstances that surround it, is left unable to exercise meaningful control over his investment § Court found the R exercised meaningful control over his investment, so this does not apply o R then claims that his membership interest was a stock § Court found R’s membership interest was neither denominated a stock nor did it possess all the usual characteristics of a stock v Notes:
  • Howey Test for Investment Contract: o Scheme/transaction/contract, invest money o Common enterprise § Pooling of money is evidence of a common enterprise o Led to expect profits o Solely from the effects of a third party § (The solely factor has been relaxed, but in this case court found the R exercised a lot of control )
  • Business enterprise is worried about whether it is a security or not (because they have to comply with securities laws)
  • But then you do have some people who purchase in bulk thinking they will appreciate in value § What about a bond? You are not really purchasing ownership when you buy a bond, but that is considered a security
  • Context Clause at the end of Rule 10(b)(5) à just because this looks like a security, if the context provides otherwise it won’t be deemed a security o For many scholars, attorneys, this does satisfy the Howey Test, but the circumstances provide otherwise (this is a government entity, most people buy these for consumption) o Lin says: if FedEx did this, it probably would be a security (a private company) R (how could he limit his liability) G Active role Active role Negotiate for indemnity provision Give R a minority management-­‐ v Subject to ratification of board Invest through an entity that limits your liability (LLC/LP) What can you do in the operating agreement to get out of Federal Securities rules? v Put language to show your intent to carve out a special role for this person
  • Why do you think a lot of partnerships, limited partnerships and LLCs still violate Federal Securities rules? o Courts look to “economic reality” (what is actually happening), you say that this person has an active role but in reality the person does not o These entities are different from a corporation where ownership and management is kept separate initially (centralized management) § The people in these other entities usually want to exercise more control over their investment Rule 10(b)(5) of Securities Act: o 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." o Notes: § Unlawful: you can be subjected to criminal and civil sanctions (SEC) § (b): Can’t lie and can’t lie via omission § (a) and (c) requires strong showing of scienter (intention to defraud) § With (b) courts are more lenient about showing scienter § Material factà has to be pertinent to the transaction § In connection: has to be dealing with a security Basic Inc. v. Levinson Facts:

  • During the time Combustion was negotiating with Basic, Basic made three public statements denying it was engaged in merger negotiation
  • Former Basic shareholders sued Basic and its directors asserting that the Ds issued 3 false or misleading public statements and thereby were in violation of 10(b) of the 1934 Act and of Rule 10b-­‐5 (causing them to sell their shares at lower prices) Issue: What is that standard of materiality applicable to preliminary merger discussion and is there a presumption or reliance? Findings:
  • Standard of Materiality:
  • Court adopts TSC 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” o However, merger negotiations are speculative in nature, so it is difficult to ascertain whether the “reasonable investor” would have considered the omitted information significant at the time
  • Court adopts the probability/magnitude approach àmateriality will depend at any given time upon a balancing of both the indicated probability that the event will occur and the anticipated magnitude of the event in light of the totality of the company activity (merger has great magnitude) o “It would have to alter a reasonable investor’s investment calculus by changing the total mix of information out there” v Notes :
  • First determine whether the statements were untrue, then determine whether the statements were material
  • You put in the order to sell your stock to your broker before the information came out o NOTE: § If you make factual misstatements, but the correct information is out there , you do not violate Rule 10(b)(5)
  • If the mistake doesn’t get fixed quickly – could be in violation § Court finds that Rule 10b-­‐5 constitutes an essential tool for enforcement of the 1934 Act’s requirements (it can be invoked by a private party )
  • How reliable is the market à there are lots of criticisms about this o How do you evaluate how much something is worth? § Evaluate what they make or what they are going to make in the future? § What does the stock price reflect?
  • In the short run, we vote on what is most popular and fluctuates o Stock process does not always reflect what the company is worth
  • Long run – like a scale, it does not change § How efficient are we as reasonable investors in processing all the info out there? GOOGLE ARTICLE
  • Google was a private company and now wants to become public (has to comply with SEC Rules)
  • Part of SEC rules is that you want everyone to have the same information o After you file registration statement, SEC puts you in a quiet phase (you can’t say anything that will alter the market) o It came out that Google had spoken to Playboy (and magazine came into print before they went public), so Google decided to disclose interview to SEC
  • If Google had not disclosed interview and SEC decided it contained material facts, Google would have had to buy back every share they released
  • What were some misstatements or things that could be material (could influence investors’ decisions)? o Amount of employees was not quite accurate (50 employee difference) o Product development (how they will use Google in the future, that they want to expand) o How they have dealt with legal issues o Advertisers o Their moral outlook o The company atmosphere/building
  • The attorneys argument for not putting the article in the registration statement is that this is publicly available information (but SEC says they want to make life as easy as possible for the reasonable investor, so we are going to require that all material information should be put into the registration statement )

APPLE ARTICLE

  • Jobs, Apple’s CEO, had been sick with cancer in the pastàthere was a rumor that went around saying that he had cancer again (he looked sick) o CFO said “Steve loves Apple. He has no plans to leave Apple. Steve’s health is a private matter.”
  • Are there any potential omissions of material fact? o Is the health issue material? § Argument for it being material à (will it affect the total mix of information?) - Jobs is the leading investor of Apple, alter-­‐ego of Apple-­‐ therefore his health would be material to stockholders because he would not be able to control/management the company (diminished capacity) - History of stock price movement when Steve has stepped away from company o Courts don’t think this factor is as important à not a good indicator for why something is material or not (because there are a ton of things that show correlation with stock prices) § Argument for it not being material à - Death is inevitable-­‐ we are all going to die and could die at any moment (this is already disclosed and accepted-­‐ it is known) - Secrecy-­‐ competitive advantage (this could hurt the corporation) - Private matter-­‐ not disclosable (i.e. what if someone had AIDS?) - Did not affect job performance/company performance (it takes a lot of people to operate) - Cancer information has already been taken into consideration (investors have already priced this information in) o Where do we draw the line on private matters? § When it affects the person’s ability to do their job
  • “You need to put yourself in the shoes of a reasonable investor and ask whether it would alter your investment calculus, if it will, then it is material”
  • Final note: o This actually affects small companies much more than big companies (where the founder/CEO is super important to the company)