LLM Law Outlines Corporation Outlines
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A. Rule 10b-5 and Securities Fraud
Securities transactions are regulated by federal + state securities law
Securities Exchange Act of 1934 then SEC made rules accordingly
Anti-fraud provisions bars deception/ misrep in securities transactions
10b-5 is a catch-all rule, governs disclosure in all purchase and sales of securities
SEC 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 [lie] 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.
S.10(b) of 1934 Securities Exchange Act: Regulation Of The Use Of Manipulative And Deceptive Devices
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 a national securities exchange or any security not so registered, or any securities- based swap agreement 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
Elements of cause of action under Rule 10b-5 (see Part III’s discussion of Rule 14a-9)
Implied right of action (Borak, cited in Virginia Bankshares)
not stated under Rule 10b-5 and 14a-9
private party can sue, but additional condition for causation and reliance
Standing to sue (Blue Chip Stamps, cited in Virginia Bankshares)
Blue Chip: only actual purchasers and sellers can sue (not those who didn’t trade)
Materiality Basic Inc. v Levinson
Causation Basic Inc. v Levinson
Reliance Basic Inc. v Levinson
Scienter (intent/knowledge): P needs to show that D acted with the intent to deceive/ knew that a statement made was false (or that D showed reckless disregard for truth) [mere negligence is clearly not enough]
Pleading standard: s.21(D)(b)(1),(2) Exchange Act - How will P obtain the requisite info to meet the pleading standard before discovery
Basic Inc. v Levinson (1988) Supreme Court P.2 [Dec 3]
Latitude of companies to deny rumors about important new developments which the company is not expressly required to disclose under the reporting provisions of the Securities Exchange Act
Evidence necessary to establish reliance under Rule 10b-5 (c.f. treatment of reliance under Rule 14a-9 in Virginia Bankshares and Mills)
Standard of materiality under Rule 10b-5
Applying
(1) Rule 10(b) of the Securities Exchange Act of 1934, and
(2) Rule 10b-5 of the Securities and Exchange Commissions, in the context of preliminary corporate merger discussions
Facts:
Board of Basic In. (previously a public co.) engage in merger negotiations with Combustion (acquirer)
Board of Basic issued 3 public statements denying that it was engaged in merger negotiations
Basic eventually enters into a merger agreement with Combustion, $46/share in Dec 1978
Shares of Basic increased (since there is always a premium in mergers, price usually increase afterwards)
Former Basic shareholders
who sold stock after Basic’s first public statement and before the suspension of trading, at an artificially depressed price, in reliance of D’s misleading statement
brought a class action against Basic and its directors, asserting that Ds issued 3 false and misleading public statements, in violation of s.10(b) of 1934 Act and of SEC Rule 10b-5
measure of damages – between the price they sold their stocks and what their stock worth now
Huge damages and serious consequences - potential jail time
Basic lied because
there were called by NYSE, which noticed the trading volume suddenly went up (which indicates rumors are floating around) Basic could have said nothing, but most companies would answer NYSE’s questions
Basic did not want to create false hope (if the deal didn’t go through, Board would be under pressure to increase share price)
Didn’t want to incur another bid + Combustion asked the deal to be kept silent
[No personal aim – e.g. insiders can buy shares and personally profit from the opportunity to buy]
(1) Materiality of the misstatements
If misstatements not material no issue
Materiality: reasonable investor would consider important in making investment decisions
DC held misstatements were immaterial CA reversed: preliminary merger discussions are material once a statement is made denying the existence of any discussions, as it make the statement untrue.
‘Fraud-on-the-market theory’ to create a rebuttable presumption that the shareholders relied on the company’s material misrep
Supreme Court Approach:
1934 Act was to protect investors against manipulation of stock prices
Adopt the standard of materiality in TSC Industries v Northway (in proxy-solicitation context) for SEA s.10(b) and SEC Rule 10b-5 context:
An omitted fact is material if there is a substantial likelihood that a reasonable shareholder would consider it important in deciding how to vote
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 info made available
Since merger negotiations are contingent/ speculative it’s difficult to ascertain whether the reasonable investor would have considered the omitted info significant at the time
Court rejected Plaintiff’s ...
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