Quiz 46: Securities Regulation


Case summary: Corporation A and Corporation B were involved in merger discussions but Corp. A made a public announcement denying the fact about the merger. But after six weeks of this denial, they both came into a merger and the stock prices of "Corp. A" rose by 25 percent due to this merger. A class of former shareholders who sold the shares of Corp. A after it denied any merger with Corp. B sued Corp. A stating it made material misrepresentations of fact in denying the merger activity. "Corp. A" argued that initially, the merger agreement was in the initial stage and nothing has become substantial and thus it denied the merger activity. It also stated that the shareholders made no showing that they relied on the denial statements. Conclusion: As it is said by Corp. A that denial to merger was announced because nothing got substantial at that time and after six weeks when things were sorted as per the agreement of both the corporations, the merger took place. And there is no other intention behind this denial or misrepresentation of the same. Thus when the shareholders sue Corp A for this kind of fraud then they are wrong and are not taking this merger sportingly. Also the shareholders do not have proves that provides a reason that they sold the share after the denial of merger news was announced. Thus there is no case that goes against Corp A.

Refer to the case United States v Falcone to answer question as below: Facts to this case • A news company had a reputation for increasing stock price when they print out favorable reviews of the companies. • The news wasn't release to public until distribution. • A stockbroker (defendant) got someone in the company to fax him the unreleased news beforehand. Case Issue The issue is whether the defendant's activity was illegal. Relevant Terms, Laws, and Cases Insider Trading - happens when an insider, person working with the company, uses information of his company to achieve an unfair advantage in an investment. Misappropriation Theory of Insider Trading - is stealing non-public information from an employer to gain an advantage in any stock. Analysis and Conclusion The Securities Exchange Commission (SEC) used the misappropriation theory of insider trading for this case. The court upheld the charges. They argued that: • Misappropriation theory relied on two factors, breach of duty of the insider to his employer, and the tipee's (person receiving the insider info) knowledge of the breach. • The insider breached his duty because there was a policy that the news cannot be distributed to the public prior to the certain time, but he faxed the news prior to delivery to the tipee. • Furthermore, the tipee was aware of the plan and paid for the faxed information. • These satisfied the evidence for misappropriation theory. Defendant is guilty of misappropriation of insider information.

SEC Rule 10b-5 prohibits use of fraudulent or omission of material information during a sale of security. If an investor purchases a stock based on fraudulent or omissions, he may recover for damage when the stock loses value. In this case, the investor purchased a stock in a company believing that the company's drug will be a success. However, the company had pointed out the drug may not work as well on humans, the stock later drop in value due to the drug's failure. This is a disclaimer would tell the potential risk of investors on relying on the company's drug as an investment.

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