• Background: Structure of the Markets and Regulation.

• Disclosure and Materiality.

o Materiality.
 DEFINITION: There must be a substantial likelihood that the disclosure
of omitted fact would significantly alter total mix of info made available
to the reasonable investor (TSC Industries)
 STANDARD: In determining the materiality of a contingent event, two
things must be considered: the probability the event will occur, and
the magnitude of the event. (Basic)
 “Truth on the Market” defense - If market knows, then the failure to
disclose or the omission or false statement is, in effect, immaterial.
(Wieglos)
 Puffing (general representations) about auction process would not lead
reasonable investor to pay more for stock than its worth, as it is a
common practice for someone to be optimistic when selling and only
unreasonable investors would attach importance (Eisenstadt –
auction “going smoothly”)
o Forward Looking Information, Bespeaks Caution and MD&A.
 “Bespeaks Caution Doctrine” - Cautionary language ( substantive and
tailored to the situation) in an offering document negates the
materiality of an alleged misrepresentation or omission, making
forward-looking statements non-actionable (Kaufman)
 Cautionary language must be meaningfully cautionary - factual inquiry
to determine if factors/potential variances included in language were
the ones the company really thought were the most important (Asher
– statutory safe harbor for forward-looking statements)
o Corporate Governance, Management Integrity and Violations of Law.
 Quality of mgmt is a material fact, reflected in interested transactions.
(Franchard)
 Inside directors have duty to know substance of interested transactions
negotiated by outside directors, and to know what should be disclosed
to SH's. (Grace)
 Criminal prosecution of transactions does not preclude SEC from
instituting an action for failure to disclose the same activity, as long as
remedies are mutually exclusive. (Schlitz)
• What is a Security? Follow these steps: (1) Is it stock?... (2) If not, apply Howey Test
o §2(a)(1) List - stocks, promissory notes, investment contracts, bonds,
debentures, fractional undivided interests in oil/gas/mineral rights, collateral
trust certificates, etc.
 Stock is a security
• Exception: “Stock” not a security if the “stock” lacks the usual
indicia of stock, i.e. being non-transferable, no right to
dividends, just calling it stock doesn't make it stock) (Forman)
• no more “sale of business doctrine”, if called stock and has
stock’s characteristics, purchaser justified in believing fed sec
laws apply; fed sec laws apply not only to passive investors but
also when control is transferred to “entrepreneurs” (Landreth)
 Promissory Notes are securities:
• Exception: Family Resemblance Test can rebut presumption
that note = security (Reves)
o Seller and buyer intent – was it for investment/financing?
did buyer want profit?
o Plan of distribution of instrument – many ppl buying it?
Trading? Then security.
o Reasonable expectations of investing public – reasonable
reliance, then security
o Existence of another regulatory scheme? – Do investors
need Sec Act protection?
o Investment Contracts (Howey Test)
 Investment
 In common enterprise
 With expectation of profit
• Profit must be primary purpose (Forman – no)
• This prong passed even if rate of return is fixed (Edwards –
yes)
 Solely from the efforts of others
• “solely” should be read as “primarily” (Edwards – yes)
• Investor inexperience/unfamiliarity with sector proves no
reasonable expectation of investor control – (Leonard – yes,
LLC)
 • Pre-purchase services of promoters and post-purchase
ministerial functions not enough to meet this prong – (Life
Bookers – no)
o Partnerships, LLC’s and Other Businesses.
 Partnerships – Since partnership interests are not on the laundry list
of "securities," you have to put them through the Howey Test.
• Big issue with 4th prong: “Solely from the efforts of others”
o General partnerships – almost never pass 4th prong
 Exception: general partnership could be security
where 1) the agreement left one partner/venturer
with such little control that it is more like limited
partnership; 2) the partner was so inexperienced
or unknowledgeable in the field; or 3) the partner
was dependent upon unique entrepreneurial or
managerial ability of promoter or manager
(Williamson)
 Limited partnerships – frequently pass 4th prong
b/c usually limited partner cannot manage the
corporation and must rely on the efforts of others
to run the business.
 LLC’s – same type of analysis as GP/LP, but LLC members likely
participate less than in GP since they have limited liability -> less likely
involved in mgmt -> more likely to pass Howey’s 4th prong.
o Real Estate.
 When the seller of real estate offers a collateral arrangement offering
some post-acquisition , a condo may be an investment contract.
 Key inquiry --> whether the condo is coupled with a service contract
and profits are expected from the purchase of the condo.
• Hocking (distinguished from other real estate sale cases) -
facts creating genuine issue as to whether condo and RPA were
part of same package/transaction was enough to defeat SJ
motion – emphasis placed on economic benefit of managerial
efforts of third party
o Notes, Derivatives, etc. Ch. 2.F-H (Text pp. 65-91).
 Notes: See Promissory Notes and Family Resemblance Test from
Reves, at top of page 2
  Derivatives: FINISH THIS!!!!!!!!!
• The Public Offering.
o Issuer (company) arranges with financial firms (underwriters) to distribute
securities to investors
 Two types:
• Firm commitment offering – Underwriters act as dealers i.e.
they commit to purchase securities (actually buy them) from
the issuer and resell them to the public at a fixed price. Their
commission is the difference b/t purchase price and resale
price.
• Best efforts offering – Underwriters act as brokers i.e. they
help the issuer sell the securities. Their commission is a
percentage of the offering proceeds from shares actually sold.
Best efforts offering may be in the form of “straight” (least risky
to underwriter), “mini/maxi” or “all or none” (most risky to
underwriter) depending on the threshold number of shares that
must be sold before the offering can close and the underwriter
can earn its commission.
o Process/Documents:
 Letter of Intent: Worded not to be binding, indicates managing
underwriter’s willingness to organize the offering
 Issuer has to get company ready for offering: preparing financial
information SEC will need, making sure house is in order, etc.
 Registration Statement: Includes the prospectus, describes the
offering and issuer, must be filed with the SEC, and the prospectus
becomes principal selling document for offering; prepared by counsel
for issuer and reviewed by counsel for managing underwriter
 Comfort Letters: Issuer’s counsel sends to underwriters letting them
know house is in order and also confirming accuracy of
financials/accounting.
 Agreement Among Underwriters: Once syndicate is assembled,
underwriters enter into agreement right before registration statement
becomes effective, authorizing managing underwriter to negotiate with
issuer on their behalf.
  Underwriting Agreement: Issuer enters into this with each
underwriter, and it is signed on their behalf by managing underwriter
(who drafts it) after the market closes on the night before the offering:
specifies price and amount of securities offered and each underwriter’s
allotment
 Selling-Group Agreements: Underwriters enter into agreements
with securities firms that act as retail dealers (“selling group”),
finalized just before offering begins (this isn’t done if the underwriter’s
firm has an in-house retail department)
o Four classes of issuers - Rule 405
 Well-known Seasoned Issuers (“WKSIs”) – enormous amount of
securities outstanding; through the “automatic shelf registration
process,” issuer can file a three-year registration statement and re-file
every three year; registration becomes automatically effective when
filed and without SEC staff review.
 Seasoned Issuers – eligible to use Form S-3 to register securities; can
incorporate company-specific information by reference from ’34 Act
filings.
 Unseasoned Issuers – use Form S-1; applies to IPO and companies
that have been public for only a short period of time (~ 2 years)
 Non-reporting issuers – issuers that are not required to file ’34
reports.
o Registration of Public Offerings
 Registration for Non-reporting issuers
• Pre-filing period – begins when issuer prepares for offering –
“in registration”
o Prohibited: Offers (5(c)), Sales (5(a)(1)), Deliveries (5(a)
(2))
o Permitted:
 Prelim negotiations with/among underwriters
§2(a)(3)
 Issuer announcements of proposed offering - Rule
135
 Issuer communications 30+ days before offering -
Rule 163A
 Regularly released information - Rule 169
 • Waiting period – after registration statement is filed, before
effective
o Prohibited: prospectus unless it complies with §10
o Permitted:
 Oral offers (unless SEC issues refusal
order/investigation)
 Prelim negotiations with/among underwriters-
§2(a)(3)
 Tombstone ads, IDing statements interest
requests-§2(a)(10(b)
 Preliminary (red-herring) prospectus - §10(b),
Rule 430
 Summary prospectus - §10(b), 431
 “Free-writing pro” with/after prelim pro §10(b)-
Rules 164, 433
o Required: Distribution of preliminary prospectus-Rule
15c2-8
• Posteffective period – after becomes effective, until offering
ends
o Prohibited: prospectus unless it complies with §10
o Permitted:
 Oral offers (unless SEC issues stop order)
 Distribution and Sale of securities
 Tombstone ads, IDing statements interest
requests-§2(a)(10(b)
 Free-writing communications - §2(a)(10)(b)
 Final prospectus - §10(a)
o Required:
 Written confirms for allotment sales & dealer
sales - (5)(b)(1)), Rules 172, 174, Rule 10b-10
 Delivery of notice within two days after sale -
Rule 173
 Registration for WKSIs (WKSI =
• Pre-filing period
o Permitted
 Oral offers – Rule 163
  “Free-writing pro” with/after prelim pro §10(b)-
Rules 164, 433
 Regularly released forward-looking info – Rule
168
• Waiting period
o Permitted
 Free-writing prospectus w/out prelim prospectus –
Rule 433
• Posteffective period
o Permitted
 Free-writing communications w/out prelim
prospec – Rule 433
o Required
 Notice delivery only applies to allotment sales -
§4(3), Rule 174
 Contents of Registration Statement
• Form S-1 - for non-reporting issuers (making IPO) or small or
unseasoned reporting issuers; the reporting ones who are
current in Exchange Act filings for the past year can incorporate
company-related info by reference to SEC filings
• Form S-3 – for large, seasoned companies that have been
reporting for at least one year; streamlined prospectus
describing particular offering, prospectus can incorporate by
reference info from company’s reports filed under Exchange Act
• Exempt Transactions.
o always check for integration, which may make transaction not qualify for
exemption
o Private Placements.
 Section 4(2) exempts “transactions by an issuer not involving any
public offering” – turns on whether the particular class of persons
affected need protection of the Act.
 For 4(2) exemption to apply, investors must:
• Be sophisticated (i.e. can “fend for themselves”);
• Have access to info substantially the same as that found in
the reg statement
• NOTE: Burden of proof is on the Issuer. (Ralston)
  Factors to consider for exemption (Doran): (NOTE: not dispositive)
• 1. Number of offerees – but focus on access & sophistication,
relation to issuer, since this is not quantitative – WORRIED
ABOUT PROTECTING THE INVESTORS
• 2. Number of Units Offered;
• 3. Size of the Offering; and
• 4. Manner of the Offering.
 Resale restrictions: You want to make sure investor isn’t trying to resell
or exemption fails.
• “Investment letter” – signed statement from investor that s/he
is purchasing this security for “investment purposes and
without a view to distribution”
• Inscribe a legend on the certificate of stock – disclosing that this
security is unregistered may be transferred only if specified
conditions are met.
 Stop-transfer order – instructs the transfer agent not to process any
transfer of restricted securities without the consent of the issuer.
 If purchaser violates resale retriction, issuer okay as long as did
one of these things
o Regulation D Limited Offerings, Integration.
 Reg. D is a safe harbor covering both private placements and limited
offerings.
• Must register Form D within 15 days of first sale if using one of
these exemptions
• Failure to comply fully doesn’t matter if insignificant.. if it didn’t
harm investor
• Integration may destroy any of these exemptions: To determine
integration, ask if one of these fits: 1) Single plan of financing;
2) Same class; 3) Timing; 4) Type of consideration; 5) Same
General Purpose
• Three Rules for Reg. D:
o Rule 504:
 an exemption for small offering of up to $1M
(usually start-ups);
 not available for reporting or investment
companies;
  no limit on # of purchasers
 resale restriction (unless state blue sky allow, or
certain circumstances)
 no affirmative disclosure requirements, but
States may require disclosure filings –blue sky
laws regulate this pretty much
 Prohibits general advertisements unless blue sky
allows
• Not general if pre-existing relationship
with offeree
o Rule 505:
 an exemption covering offerings of up to $5M;
 limit of 35 non-accredited purchasers; accredited
investors not counted
 affirmative disclosure obligations to non-
accredited investors
 resale restriction
 Prohibits general advertisements: must have pre-
existing relationship
o Rule 506:
 safe harbor for a § 4(2) non-public offering
exemption;
 no limit on offering amount;
 limit of 35 non-accredited purchaser;
 non-accredited investors must meet affirmative
disclosure obligations + sophistication
requirement (knowledge/experience) 506(b)(2)(ii)
 resale restriction
 Prohibits general advertisements: must have pre-
existing relationship
o **Rule 501(a)** – Definition of “Accredited
Investor” – (can fend for selves.)
 Institutional investors, big organizations ($5mil
assets), key insiders (of the issuer), millionaires,
fat cats, venture-capital firms, sophisticated trust,
accredited-owned entity.
  NOTE: if issuer reasonably believes investor is
accredited, it counts
o Regulation A of the Securities Act of 1933 (aka Reg A) exempts small
offerings of securities from the regular SEC registration if these conditions
are met:
• The public offering is not for more than $5,000,000 within a 12-
month period.
• The offering statement, which is a simplified disclosure
document, must be filed with a Regional Office of the SEC at
least 10 days before the issue is offered for sale.
• The offering circular, which is similar to the prospectus in
providing full disclosure, must be sent to each buyer of the
issue at least 48 hours before the confirmation of the sale.
• The offering circular must be revised if the issue is still being
offered 9 months after the initial issue, and the issuer must file
a sales report of the issue with the Securities and Exchange
Commission (SEC) every 6 months until the offer is terminated.
• Secondary Distributions: How Can I Sell My Stock?
o §4(1) - an exemption that allows transactions by persons other than issuer,
underwriter or dealer – they are exempt from the registration requirement of §
5 ’33 act
 Everyone involved is PRESUMED TO BE UNDERWRITER unless proves
otherwise
 if determined to be underwriter, this section can’t apply, and you have
to try 4(2), § 4(1)
• Possible “underwriters” who don’t get exemption:
 persons who buy unregistered securities in a private
placement or other exempt offerings and now want to resell
them (without waiting)
 persons who sell securities on behalf of “control persons”
(persons who control, are controlled by, or are under
common control with, the issuer (e.g. management,
directors, major shareholders) (Wolfson)
  §2(11) does not say that a "control person" is an issuer and
therefore subject to the registration and prospectus delivery
requirements. Rather, it only says that solely for the
purpose of determining whether another person is an
underwriter, the term "issuer" also includes "control
persons". That is, one can be an underwriter if one buys
securities directly from issuer itself or if one buys them from
an officer or director of the issuer (because of the danger
that she is acting indirectly for the benefit of the issuer).
• “Underwriter” is broadly defined to include:
o any person who purchases from an issuer with a view
to distribution (i.e. a typical firm commitment
underwriter)
o any person who sells for an issuer in connection with
distribution (i.e. best efforts underwriter)
o Any person who participates, directly or indirectly, in
any such undertaking
o CHINESE CONSOLIDATED: issuer need not authorize
or compensate selling activities of solicitor for that
solicitor to be considered an “underwriter”, since
purchaser still deserves the information and protection
of registration.
o §4(1½) – Exemption construed to provide for the private resale of securities
to sophisticated investors
 resale of securities to private, sophisticated investor (Ackerberg –
not “UW” if securities held for a while before resale – like the
holding period in Rule 144) – Control person/affiliate can use
 You still wanna ask if its an UW, etc, just like with 4(1) so this is
pretty much 4(1) analysis but it is just specific to resales for private
investors, not issuer
 Just like a 4(2) exemption (but for non-issuer/uw/dealers and for
resale) – limited number of purchasers, disclosure of info that would
be given in private placement, sophistication req, - also you have to
wait 6 or 12 months before reselling – don’t have to follow all the
4(2) req’s though.
  If purchaser (non-issuer) bought securities without original intent to
distribute them, but at a later time decides to resell them, he/she/it
may do so without destroying the relevant exemption only if the
resale buyer is "sophisticated" and provided with the same
information as would be available if the securities were registered.
o Rule 144. If restricted securities are being redistributing publicly (mutually
exclusive of 4(1½ ) – Control person can use this. (if volume too high, or
problem like that, try 4(1.5).
 Persons selling restricted shares pursuant to Rule 144 will not be
deemed an underwriter – safe harbor for ordinary public trading (can
be control or noncontrol person, as long as follow rules -285 – different
for affiliates/non-affiliates)
 Restricted securities—as defined in Rule 144(a) (3)—are
securities that can be resold under Rule 144 - Important for the
investor to meet this definition
 “Restricted securities” include: securities acquired from
issuer in a transaction not involving any public offering;
securities acquired from issuer that are subject to the resale
limitations, such as securities acquired in §4(2) private
placement, Reg. D offering, or 144A transactions.
 Securities acquired in an intrastate offering are NOT
restricted securities.
 If the subscription statement contains the resale limitations
provision, the investor can invoke Rule 144 in resale, even
though the issuer actually failed to qualify for Rule 505, for
example.
 Mandatory holding period à this requirement is to track
the case law on investment intent.
 A non-affiliate of a public company cannot resell during the
first 6 months, can resell subject to conditions during the
next 6 months (i.e. current information condition), and after
1 year, can do free trading.
o Rule 144A. Institutional Trading: codifies 4(1½) for institutional
investors (ALL are QIB, no holding period)
  Rule 144A permits the sale of unregistered securities to qualified
institutional buyers (QIB), which are institutions—banks, insurance
companies, etc.—that invest at least $100 million in securities from
issuers not affiliated with the QIB. This is how most unregistered
foreign securities are sold in the United States. – collateralized debt
obligations
 Figure out if it is a QIB or not -
 Like 4(1-½)
 4(1.5) allows individuals to resell unregistered securities to other
individuals;
 144A enables institutions to resell unregistered securities to other
qualified institutions
• Reorganizations and Acquisitions. – need to finish.
o The Sales “For Value” Requirement of Section 5:
o Generally - Section 2(a)(3) says that only a sale “for value” must be
registered under section 5. When an issuer sells shares in a public
offering, it is very clear they are selling the securities for value, and that
these sales must be registered under section 5. On the other hand, cash
or stock dividends are clearly not “for value”, as the corporation gets
nothing in return; therefore, these transactions need not be registered.
o Unclear Transactions – Are they “For Value” and Subject to
Registration?
 Cash or Stock Choice Dividend - When corporations give
investors a choice – you can have a cash dividend or a stock
dividend. In this case, the SEC says that since neither of these
dividends on their own is considered “for value”, we do not make
the corporation register this as a sale.
 Cash Dividend, Converted to Stock - However, if a corporation
declares a cash dividend, and only afterward decides to give people
the opportunity to get a stock dividend instead of the cash, this
must be registered as a sale. Why? The moment they announce a
cash dividend, the cash belongs to the stockholders. If they then
trade this for a stock instead, they are really buying the stock – it is
for value.
  Materially Amending the terms of a security (stocks or
bonds) – is this considered a sale that must be registered? To
change the terms, you must take a vote among shareholders to see
if they will accept the proposed change. When you make this
change of terms, is this really an exchange of the old stock for a
new type of stock, which qualifies as a sale? The prevailing view is
that if the terms are changed in any significant way, this is
considered a sale that must be registered. However, there is an
exception under 3(a)(9) that can exempt a change of terms from
registration.
 Converting a Security – when you convert preferred stock into
common stock without making any additional cash payments
o Spin offs – only permitted with legit biz purpose, also focus on SH’s getting
info or not
 issuance, by a company with little or no business activity, of some
of its shares to a publicly owned company for a nominal
consideration.
 publicly-owned company then spins off its shares as a distribution
to its shareholders. Creating a public trading market into which the
insiders can sell the remaining shares.
  the total transaction requires registration under 33 Act, even
though the distribution to the shareholders of the public-owned
company is not a sale. SEC v Datronics [4th 1973]
 reason for Datronics holding: Spin-off with no legitimate
business purpose is a “sale” under the ’33 act because it creates a
market for the new securities; therefore, new securities must be
registered
o Shells
 shell corporation is one which has ceased active operations and has
little or no assets, but has substantial amounts of stock held by
members of the public.
 promoters obtain control of the company, engage in a series of
acquisitions or other transactions which cause the market price of the
stock to rise dramatically, then take advantage of the inflated market
to sell the shares that they have acquired.
   SEC said that transactions of this type violate both the registration
and antifraud provisions.
 Exchanges and Reorganizations In and Out of Bankruptcy. Ch. 7.C-D
(TEXT pp. 417-428).
• “For
• 1933 Act Liability.
o §11 Liability – misinfo in reg statement
 P – “acquirer” of securities (hard to show if didn’t get them directly
from UW or Dealer)
 P, if an acquirer, just has to show material misrepresentation in reg.
statement.
 Culpability, reliance, causation are defenses.
 Potential Defendants = UW’s, Issuers (and its officers), some experts
who were involved
• Damages = 3 possibilities 11(e) – difference between the
amount paid for security (not greater than public offering price
and:
o The value of securitiythe date suit filed if security still
held
o The price of securitiy if sold before suit is filed
o The lesser of the above two options if sold before
judgment but after suit filed
o §12 Liability
 12(a)(1)
• Unregistered, non-exempt securities or violation of gun-jumping
– violating §5
• Damages = rescission or rescissionary damages if sold
 12(a)(2) – for misinfo in prospectus or oral communication
• kind of extension of §11 for purchasers of securities (not just
acquirers like in §11)
• Purchasers may seek rescission from “statutory sellers” if the
offer was carried out using prospectus or oral communication in
offering with material false or misleading statements.
• Reasonable care defense can be raised if they show they didn’t
know of misinformation.
o §17(a) Liability
  liability on sellers of securities – whether public/private offering or even
for exempt ones
 liability for negligent misrepresentations, broad sweeping to prevent
any fraud
 Prohibits sale of securities using jurisdictional means that
• Employs ‘artifice to defraud’
• Obtains money by means of material misstatement or
misleading omission, and
• Engages in actions that ‘operate as a fraud’
1934 Act Liability: Securities Fraud.
• Scope of Rule 10b-5: ‘In connection with the purchase or sale of a security’
o Covers all types of securities and all types of transactions (a last resort
provision for Ps)
 D does NOT have to be party to a transaction; D’s actions must
merely be reasonably calculated to influence the investing public.’
(Texas Gulf Sulfur)
 P has to be involved in a purchase or sale. Blue Chip Stamps v.
Manor Drug Stores (U.S. 1975)….. thus the SC limited the TGS
standard from excessive exploitation in private suits. SC’s tone
was aggressively set against the rise of the securities class action
industry that arose following TGS).
 In connection with…’”
• (a) No showing of causality required
• (b) Simply requires some nexus between the sale of
the security and the alleged fraud (eg, typically
courts accept that such nexus when time overlap, eg,
defective disclosure in Jan is not discovered until
June; anyone who purchases secs from Jan to June
can be a P in the lawsuit)
• (c) Security sale must be the main part of the fraud
(not a larger investment scheme with a security
incidentally involved)
 What is a purchase or a sale? It includes –
• Sales as defined in the 33 Act
• transactions that impose encumbrances, such as
pledges. Chemical Bank
 • Issuance of securities
• Options
• Agreements to purchase stocks in the future:
Promissory Fraud. Wharf
 Scienter (recklessness counts, negligence doesn't)
 P must be aware that her actions are actually going to harm
investors. (Hochfelder)
 Recklessness – yes… (awareness of true state of affairs
and “could reasonably foresee result” is enough – AUSA Life
Insurance v. Ernst, Sanders, Broad
 Scienter may be satisfied if—
• (1) D actually intended the fraud, or
• (2) D was aware that her actions could possibly result
in defrauding investors, and she was okay with it.
AUSA.
o Does ignorance of the law constitute scienter? - Ds
cannot claim ignorance of fraud if the statement is
material enough – usu in auditing and in accounting
statements.
• The Duty to Disclose under 10b5.
• If a corporation speaks, must speak accurately (Basic v. Levinson)
• For now, corporations only have a duty to reveal material information to investors
periodically – annually and quarterly. The real question becomes “gap
disclosure” – what duty does a corporation have to disclose material information
in between the periodic disclosure statements.
• When there is no duty to speak under securities law, the courts look to fiduciary
duty law and corporate law to fill the gaps and determine what and to whom
corporations must disclose
• Internal valuations – generally no (Facebook), but there are some unusual
circumstances
• Just because a particular officer knows fraud is going on, it does not mean the
entire company can be sued. If statements are made to newspapers, but it is
unclear who made them, can the company be sued? If a lower level person made
the statements, the company is probably not liable.
• As long as statement was true when made, no duty to update, But if company
realizes earlier statement was false, there is a duty to correct (Gallagher).
 o 3rd Circuit is tougher, and assumes duty to update exists as long as
statement “alive” (Weiner)
o also see Time Warner – P claim not dismissed, company made material
change in plans and there was no update to shareholders – could reconcile
with Gallagher since the company probably knew it was considering this
other option all along and didn’t mention it, or 2nd circuit just tougher than
7th)
o There is exception for duty to disclose material info if it would prejudice a
company objective
• New York Stock Exchange’s Additional Disclosure Requirements
o The NY stock exchange has standards for remaining listed that require
disclosure on a more continuous basis than the securities laws do,
effectively resulting in far greater disclosure among its listed companies.
• Reg. FD – If you disclose information to anybody outside of the corporate family,
you must reveal that information to the entire market through an official SEC
disclosure. (like protection against tipping, Ins Trad)
• 14(e)3 – Tender Offers
← Reliance; Causation and Fraud on the Market in 10b5
• Reliance
o Presumption of Reliance in Face to Face Dealings (Ute) – In a case
of face to face negotiations with a fiduciary we have a presumption of
reliance upon the defendant’s omissions. This presumption is based on
“the circumstances of this case” – the presumption is limited to the facts
of this case.
o Presumption of reliance in Class action (Levinson) – Fraud on the
Market - the plaintiff has the burden of proof on all of the elements of
fraud – including reliance. If the plaintiff had to prove individual reliance,
the lawyers would have to prove that each particular member of the class
relied on the omission / misstatement. This is completely impractical;
therefore, the only way to make this work is to get a presumption of
reliance. (SC adopts this)
 Defenses (Levinson) – rebutting presumption of reliance:
 Truth on the market, Severing the link between omission
and purchase, or prove EMH shouldn't apply because
company not public enough for it to work, Plaintiff’s reliance
was reckless – not reasonable at all.
 • Loss Causation
o Definition – the transaction caused the loss to the plaintiff. Loss
Causation is basically proximate causation (with some tweaks)
o Usual Situation - The plaintiff shows that he bought the price at one
price, and then the value went down because of the misstatement or
omission. The defendant tries to sever this link. (AUSA – no causation)
 AUSA – Majority focuses on foreseeability, concurrence is more pro-
defendant – asking did the misinformation cause the loss, and
dissent is pro-plaintiff – there was misinformation that was relied on
here, and otherwise plaintiffs could’ve gotten out.
 Dura Pharmaceuticals v. Broudo - 9th Circuit is Lenient on P’s
Pleading Standards – The 9th circuit held that it is enough for the
plaintiff to plead that the price of the stock was inflated on the day
I purchased it because of the misrepresentation (the company
reports inflated earnings).
 Supreme Court is Stricter - The Supreme Court says that this is
not proof of loss. You have to show not just that you bought the
stock and lost money, but that you lost money because of the
misrepresentation. The plaintiff must plead that the diminution of
price is attributable to the defendant’s misstatements. Here the
plaintiff did not even plead this!

o The purpose of the securities laws is not to protect investors from the loss
of their investments due to bad business decisions – it’s only to prevent
against fraud. The plaintiffs argue that the defendant’s fraud was the
proximate cause of the securities’ loss in value
o
← Manipulation. Ch. 12.H. (Text pp. 733-43)
• Enforcement.
o Private Rights of Action: Ch. 13.A (Text pp. 745-55).
o Secondary Liability: Ch. 13.B-C (Text pp. 755-83).
o SEC Enforcement: Ch. 13.G. (Text pp. 803-30).
o Professional Responsibility: Ch. 13.H-I (Text pp. 830-862).
 Rule 205
  SOX says SEC has authority to discipline authority; definition of
“practicing” for attorney is so broad, includes giving advice with
respect to filing or non-filing of docs and helping clients draft docs,
almost anything a sec lawyer does
 Law firm’s liability in aiding and abetting the fraud was based solely
upon silence during the course of the closing proceedings despite
knowledge of the client’s misrepresentations, rather than some kind of
affirmative misrepresentation on behalf of the client in an opinion
letter. (Nat’l Student Mrkting)
o Criminal Enforcement: Ch. 13.J (Text pp. 862-78)
o Classic Theory; Tippers and Tippees. Ch. 14.A-B (Text pp. 879-87), Ch. 14.E 1.
(Text 898-906).
 Rule 10b5 prohibits any person to profit based on material inside
information, or to be an accomplice to someone else who will profit.
 “Abstain or disclose” ALWAYS THE RULE – but can’t disclose and run,
must wait a bit (TX Gulf)
• Only have to disclose if there is a fiduciary duty, otherwise
silence not enough (Chiarella)
 Classic theory of insider trading = trade in securities of issuer on info
that belongs to issuer
• illegal insider trading occurs only when there is a breach of
fiduciary duty (Dirks)
o Duty not automatic with spouse or family; decided on
case by case basis, look at whether expressly accepted
duty to not use info, or duty based on past dealings
(Chestman)
o Insider must use/disseminate material non-public
information for personal benefit. (level of benefit unclear
– “vengeance”, giving gift may be enough. (Dirks)
o (classic) Insider:
 duty to corp/SH  Access to info as EE is not
enough (Chiarella)
• But now corps make you sign
confidentiality K’s
 Need chain of obligation of confidentiality all way
 issuer (Chestman)
  Corporate lawyer W has duty to H who relies on
her advice, trusts, confides in her (Weiss)
• Test of Materiality is a balance between: (TX Gulf)
o (1) Chance of event occurring (Goodwin – speculative
theory)
 (2) materiality of event. (merger? Etc.)… Court
generally looks to
 (3) Importance attached to information by those
who knew about it.
• Amount bought or sold can be indicative
of whether the insider thought it was
material.
• Standard for Materiality:
o Whether a reasonable investor would attach importance
to the information in determining his choice of action in
the transaction. (TX Gulf)
• Equal Access Rule (replaced by Dirks’ fiduciary duty
rule) All insider trading is illegal, everybody should have equal
access to information (TX Gulf Oil) – replaced by Dirks fiduciary
duty rule
• Tippee – liable if tipper (insider who tips) breached a fiduciary
duty to disclose the info, and tippee knows/should know there
was a breach but trades anyway.
o To have a duty, must be expectation that “tipper” would
have kept info confidential - check to see if spouse,
child, parent, sibling, etc. [10b(5) – 2(b)(3)]
o Tipper only breaches fiduciary duty if tipper gets a
personal benefit (doesn’t have to be monetary, feeling of
giving gift, vengeance, etc) (Dirks)
o Misappropriation Theory, Reg F-D, Rule 14e-3. Ch. 14.C-D (Text pp. 887-98),
Ch. 14.F-G (Text 912-18).
 Misappropriation – (O’Hagan) – CORPORATE OUTSIDER – CAN STILL
ABSTAIN/DISCLOSE
 • Breach of Fiduciary duty when person is confidentially entrusted
with information by employer and profits from information
(O’Hagan – partner at law firm may not profit from inside
information received predominantly through the partnership.)
No breach however if employee discloses and employer permits
the insider trading.
o Defenses: info not material, only speculative, no benefit to tipper/insider, gave
information inadvertently, also if you had preexisting trading plan (10b(5)-1(c)
o [14e-3(a)] for tender offers] – even when above theories don’t apply, can still
be liable for tender offers