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Quiz 37 :

Securities Regulation

Quiz 37 :

Securities Regulation

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ETHICS David Sokol worked at Berkshire Hathaway for legendary investor Warren Buffett, who is renowned not only for his investment skills but also his ethics. Bankers suggested to both Sokol and the CEO of Lubrizol that the company might be a good buy for Berkshre. Sokol then found out that the CEO of Lubrizol planned to ask his board for permission to approach Berkshire about a possible acquisition. Sokol purchased $10 million worth of Lubrizol stock before recommending Lubrizol to Buffett. Sokol mentioned to Buffett "in passing" that he owned shares of Lubrizol. Buffett did not ask any questions about the timing or amount of Sokol's purchases. Sokol made a $3 million profit when Berkshire acquired Lubrizol. Did Sokol violate insider trading laws? Did he behave ethically? What about Buffett?
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Ethical behavior of S:
B defended the purchase by saying that S had no way of knowing how B would react to the purchase suggestion. Indeed, B was originally skeptical. However, S was a top deputy who often believed to be most likely to succeed B as CEO. S quit after the announcement of the purchase, but both S and B said his departure was unrelated to L Company.

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The SEC believes that anyone in possession of material nonpublic information about a company should be required to disclose it before trading on the stock of that enterprise. Instead, the courts have developed a more complex set of rules. Do you agree with the SEC or the courts on this issue?
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The set of court rules on the issue of non-public information:
The SEC has argued many times that anyone in control of non-public material information must disclose it or refrain from trading. But the Supreme Court has consistently rejected that view. Instead of SEC's simple proposal, the courts have provided much more complex rules.
• Fiduciary rule: Any corporate insider who trades while in control of non-public material information in violation of his fiduciary duty to his company is liable under rule 10b-5.
• Misappropriation: Anyone with material, non-public information, who breaches fiduciary duty to the source of information and by trading, is liable for insider trading.

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Fluor, an engineering and construction company, was awarded a $1 billion project to build a coal gasification plant in South Africa. Fluor signed an agreement with a South African client that prohibited them both from announcing the agreement until March 10. Accordingly, Fluor denied all rumors that a major transaction was pending. Between March 3 and March 6, the State Teachers Retirement Board pension fund sold 288,257 shares of Fluor stock. After the contract was announced, the stock price went up. Did Fluor violate Rule 10b-5?
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Section 10(b) was created to protect against fraud in the purchase and sale of any security. Rule 10b-5 was adopted by the SEC in order to clarify rule 10(b) and gives more precise guidelines for establishing the cases of securities frauds.
In order to show that a violation of Rule 10b-5 has occurred, one must prove the following:
• A Misstatement or Omission of a Material Fact. In this context, the word "material" means "important enough to affect investors' decisions". Those who do not disclose material information and those who make incomplete or inaccurate statements, are liable.
• Scienter, which means "willfully, knowingly, or recklessly"? In order to be liable under Rule 10b-5, the defendant must have (1) known (or must have been reckless in not knowing) that a statement was inaccurate and/or (2) meant for the plaintiff to rely on the statement.
• Economic Loss. The plaintiffs must suffer a loss in the value of their investment. The plaintiff must also show that the economic loss was caused by the material misstatement.
Intent is also a very important part of establishing whether or not a violation of Rule 10b-5 has taken place. F did not intend to defraud or mislead stockholders by dispelling the rumors regarding the agreement, but was rather acting in good faith with the confidentiality agreement they had made with their client. Therefore, it cannot be proven that Scienter had taken place.
Because F did not act with intent to defraud stockholders and did not intend for them to rely on F's statements, F's actions did not constitute a violation of Rule 10b-5.

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Refco Inc. failed to disclose in SEC filings that millions of dollars of its accounts receivables were uncollectible. Two months after its IPO, the company went bankrupt. Shareholders filed suit against the company's law firm, alleging that it was liable under Section 10(b) for drafting Refco's SEC filings that contained these material omissions. Is the law firm liable? Should it be? Is this a stronger or weaker case than Stoneridge?
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Securities laws are a balancing act between companies' desire to raise money and investors' need for protection. Congress recently changed Rule 506 to permit advertising. Critics worry that this change will permit fraudsters to attract more victims. It is true that Rule 506 limits public solicitation to accredited investors. But just because accredited investors are financially secure, does not mean they have investment savvy. (Think doctors and lawyers.) Should Congress have made this change?
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Federal security laws are based on the assumption that investors are knowledgeable enough to assess the quality of a stock, so long as the issuer provides adequate disclosure. Many states take a different approach-they refuse to permit the sale of securities that they deem to be of poor quality. Should securities laws protect investors in this way?
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What would you say to critics who argue that: • crowdfunding does not provide enough protection to investors? • the business judgment rule will permit managers to spend the money as they will? • few of these companies will ever go public, so investors will have limited opportunities to sell their stock or realize any return on their investment?
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Three months ago, Noah bought stock under Rule 506 in TreesNFlowers, Inc. He has lost interest in the company and would like to sell the stock. Which of the following statements is true? (a) He can sell the stock now, so long as he sells it to an accredited investor. (b) He can sell the stock now, so long as the company grants permission. (c) He must hold on to the stock for at least nine months. (d) He could sell the stock in three months, but only if the company goes public in the meantime.
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CPA QUESTION When a common stock offering requires registration under the Securities Act of 1933: (a) the registration statement is automatically effective when filed with the SEC. (b) the issuer would act unlawfully if it were to sell the common stock without providing the investor with a prospectus. (c) the SEC will determine the investment value of the common stock before approving the offering. (d) the issuer may make sales 10 days after filing the registration statement.
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If a publicly traded company wishes to issue more stock, it will undertake a(n). If the underwriter buys the stock and resells it to the public, that is a underwriting. Before buying the stock, investors must receive a copy of the. (a) IPO, best efforts, registration statement (b) IPO, firm commitment, registration statement (c) secondary offering, best efforts, prospectus (d) secondary offering, firm commitment, prospectus
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Gary Griffiths was a vice president for a railroad. The CEO asked him to prepare an inventory of all the rolling stock the company owned and to arrange trips among its rail yards for a group of men in suits. Employees began asking Griffiths if the company would be sold and whether they would lose their jobs. Indeed, the company was exploring sale options. Griffiths went to visit his brother-in-law, Rex, who the next day purchased $400,000 in stock of the company. For a month, Griffiths called regularly, and each time Rex bought more stock. In total, he spent $1.14 million on company stock. After the company was sold, Rex made a substantial profit. Did Gary and Rex engage in illegal insider trading? Was the fact that men in suits were touring the rail yards material nonpublic information?
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CPA QUESTION Pace Corp. previously issued 300,000 shares of its common stock. The shares are now actively traded on a national securities exchange. The original offering was exempt from registration under the Securities Act of 1933. Pace has $2.5 million in assets and 425 unaccredited shareholders. With regard to the Securities Exchange Act of 1934, Pace is: (a) required to file a registration statement because its assets exceed $2 million in value. (b) required to file a registration statement even though it has fewer than unaccredited 500 shareholders. (c) not required to file a registration statement because the original offering of its stock was exempt from registration. (d) not required to file a registration statement unless insiders own at least 5 percentof its outstanding shares of stock.
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ETHICS Suppose that, while waiting in line at the grocery store, you overhear a stranger saying that the FDA is going to approve a new drug tomorrow-one that will be a huge success for Alpha Pharmaceuticals. Is it legal for you to buy stock in Alpha? Is it ethical? What would Kant and Mill say?
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Lily would like to raise money for her video game start-up by selling shares. If she decides to raise money through crowdfunding, she _________. (a) can only sell to accredited investors (b) can sell up to $5 million in stock during each 12-month period (c) cannot sell on the Internet, but only through an approved intermediary (d) must file an offering statement with the SEC (e) can advertise the terms of the offering
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Do you love ice cream? Here is an opportunity for you! For only $800, you can buy a cow from Berkshire Ice Cream. The company gets milk from the cow, and you get to share in the profits from the sale of ice cream. Just last month, Berkshire mailed $32,000 worth of checks to investors, who are expecting a 20 percent annual rate of return. Are there any problems with this plan?
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