Business Organizations 2010 -2011 Lectures PARTNERSHIPS, CORPORATIONS AND THE VARIANTS PROF. BRUCE MCCANN SPRING SEMESTER LECTURE 13 INSIDER AND SHORT SWING TRADING PP. 977 -1011
The Elements Material misrepresentation or nondisclosure Scienter A connection between the misrepresentation and the purchase or sale of a security Reliance Economic Loss Causation (a “causal relationship” between the misrep and the loss Lec. 12 2011 Sem 2, pp 977 -1011 Corps Prof. Mc. Cann
Loss Causation and Damages Fact price is inflated (“fraud on market” test) is not sufficient to prove the misrepresentation caused the loss. At the moment of purchase the stock is worth what was paid, so no loss. The inflated price may, but may not, lead to the later loss when the stock is sold for a lower price. Dura Pharmaceuticals, Inc. v. Broudo (reversing 9 th circuit test that plaintiff sufficiently alleged causation between the loss and the misrepresentation for 10(b)-5 purposes by alleging the price paid was inflated) Lec. 12 2011 Sem 2, pp 977 -1011 Corps Prof. Mc. Cann
Calculation of Damages Disgorgement Measure: Plaintiff may recover post-purchase decline in value up to reasonable time after purchase, limited by the total gain enjoyed by the tippee as a result of trading on the inside information. Where multiple plaintiffs, recover pro rata from the tippee. Subsequently, Sec. 20 A provided for treble damages and other disincentives in SEC prosecutions. Lec. 12 2011 Sem 2, pp 977 -1011 Corps Prof. Mc. Cann
Other Statutes Private Securities Litigation Reform Act (PSLRA) of 1995 Applies to class actions Makes it more difficult to proceed by class action in an insider information case by: Requiring plaintiffs “state with particularity facts giving rise to a strong inference that the defendant acted with the requisite state of mind” Stays discovery if defendant moves for dismissal, meaning must have your facts without access to defendant’s documents Plaintiffs must prove misrepresentations caused the loss (Dura) Lec. 12 2011 Sem 2, pp 977 -1011 Corps Prof. Mc. Cann
Other Statutes Sarbanes-Oxley Act of 2002 Creates criminal violation for executing or attempting to execute a fraud in connection with any security; Or to obtain by fraud any money or property in connection with purchase or sale of security Lec. 12 2011 Sem 2, pp 977 -1011 Corps Prof. Mc. Cann
Sec. 16 of the Exchange Act a. Directors, officers, and principal stockholders required to file Every person who is directly or indirectly the beneficial owner of more than 10 percent of any class of any equity security …or who is a director or an officer of the issuer of such security, shall file the statements …[with]… the amount of all equity securities of such issuer of which the filing person is the beneficial owner; and…shall indicate …at the date of filing, any such changes in such ownership, and such purchases and sales of the security[. ] Lec. 12 2011 Sem 2, pp 977 -1011 Corps Prof. Mc. Cann
Sec. 16 of the Exchange Act b. For the purpose of preventing the unfair use of information which may have been obtained by such beneficial owner, director, or officer by reason of his relationship to the issuer, any profit realized by him from any purchase and sale…within any period of less than six months, unless such security …was acquired in good faith in connection with a debt previously contracted, shall inure to and be recoverable by the issuer Lec. 12 2011 Sem 2, pp 977 -1011 Corps Prof. Mc. Cann
Smolowe v Delendo Must each sale unfairly use inside information before it is subject to Sec. 16? No. All transactions in the 6 month period covered. Disgorgement is of difference between highest sale and lowest purchase, times number of shares bought or sold. Purpose to sweep in all conceivable profits. Lec. 12 2011 Sem 2, pp 977 -1011 Corps Prof. Mc. Cann
Smolowe v Delendo The Real World Date Buy/Sell Shares Price 1/1 Buy 100 $115 -$11, 500 ½ Sell 100 $93 $9, 300 1/3 Buy 100 $90 -$9, 000 ¼ Buy 100 $95 -$9, 500 1/5 Sell 100 $97 $9, 700 1/6 Buy 100 $105 -$10, 500 1/7 Sell 100 $108 $10, 800 1/8 Sell 100 $115 $11, 500 Total Lec. 12 2011 Sem 2, pp 977 -1011 Corps Prof. Mc. Cann Extended $800
Smolowe v Delendo Under 16 b Date Buy/Sell Shares Price 1/1 Buy 100 $115 ½ Sell 100 $93 1/3 Buy 100 $90 Match with $115 sale = $2500 profit ¼ Buy 100 $95 Match with $108 sale = $1300 profit 1/5 Sell 100 $97 1/6 Buy 100 $105 1/7 Sell 100 $108 1/8 Sell 100 $115 Lec. 12 2011 Sem 2, pp 977 -1011 Corps Prof. Mc. Cann Total Net Profit (Loss) No other buys matched with sells generate gains. $3, 800 profit
The Universe of Defendants 16 b Means What It Says: Only directors, officers or beneficial owners of 10% of the stock are potential defendants. Ownership measured immediately prior to the transaction (i. e. , was the shareholder a 10% owner when he entered into the transaction in question? ) So, “step transaction” to reduce ownership to less than 10% will shield sale of remaining interest. Lec. 12 2011 Sem 2, pp 977 -1011 Corps Prof. Mc. Cann
But a Sale May Not Be a Sale Every conveyance of stock should be tested against purpose of the statute to determine if there is a transaction of the sort the statute was intended to disrupt, i. e. , a transaction that could benefit from insider information Lec. 12 2011 Sem 2, pp 977 -1011 Corps Prof. Mc. Cann
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