Corporations Law: Corporate Disclosure and Securities Fraud outline

 Corporate Disclosure and Securities Fraud Study Guide

A. The Disclosure System:

1. The Securities Act of 1933
   1. Narrow in focus, the ’33 Act applies essentially to the initial distribution of securities by the issuer, underwriters, and dealers who sell these securities to the public, and not to most trading transactions between investors in the secondary market.
   2. The ’33 Act’s critical instrument of disclosure is the registration statement, which contains the prospectus with all material information about the security and must be distributed to potential investors.
   3. The standard of liability was strict liability for the issuer and a form of negligence liability for the secondary participants (board of directors, accountants, etc.)
2. The Securities Act of 1934
   1. The ’34 Act created a system of continuous disclosure.
   2. It created the SEC.
   3. It created registration requirements for the secondary market as opposed to the 33’ Act’s regulation of the primary market.
   4. A corporation is required to enter the ’34 Act’s disclosure system if:
      1. It lists securities on a national securities exchange;
      2. Any class of its equity securities is held of record by at least 500 persons and the corporation has gross assets over $10,000,000; or
      3. The corporation files a ’33 Act registration statement that becomes effective.
   5. Each of these events triggers an obligation on the part of the issuer to register with the SEC and thereafter become a “reporting company” that must file periodic reports under § 13 of the ’34 Act.
      1. The most important of these periodic reports is the annual report on Form 10-K, which must contain audited financial information as well as a detailed description of the corporation.
      2. In addition, quarterly reports on Form 10-Q containing unaudited financial information.
      3. Finally, reports of current material developments must be filed on Form 8-K within ten days after the end of the month in which the event occurs,
   6. These reports are not distributed to investors or shareholders, but to the SEC.
   7. However, the SEC requires reporting companies to include a basic information package (including the MD&A) in the annual report mailed to their shareholders.
      1. The MD&A includes financial information and discussion of recent performance and an estimation of the impact of “known trends or uncertainties” upon future earnings.
3. State “Blue Sky” Regulation
4. Stock Exchange Requirements
   1. Ex. NYSE, ASE, and Nasdaq
   2. Unlike the ’34 Act, which requires periodic reports, these rules mandate prompt disclosure of material information on a continuing basis.
   3. They require a listed company to promptly any news or information reasonably expected to materially affect the market for its securities.
   4. However, these rules permit the issuer to delay disclosure for legitimate business reasons.
   5. No private cause of action.

B. When Does the Disclosure Obligation Arise?

Do publicly traded companies have a duty to make disclosures inbetween the mandatory disclosure periods?

1. Silence or “no comment”
   1. Rule 10b-5 imposes no affirmative duty to disclose, but only a duty not to tell material lies.
   2. Silence (or a “no comment” statement) is permissible. Basic Inc. v. Levinson (1988).
2. Delay of Disclosure:
   1. In Financial Industrial Fund, Inc. v. McDonnell Douglas Corp., the plaintiff argued that defendant violated Rule 10b-5 through their silence, because they could have disclosed earlier, they should have disclosed earlier, and that the delay was improper.
   2. The court holds that the corporation is entitled to withhold disclosure until the information is “available and ripe for publication”.
      1. This means that the information “be verified sufficiently to permit the officers and directors to have full confidence in their accuracy”.
      2. Information is not ripe if a “valid corporate purpose” exists for withholding the information.
   3. The rationale being that if a corporation is forced to make disclosures too quickly, it could expose itself to liability for misrepresentations if the information turns out to be false.
   4. The court held that defendant had acted with good faith and due diligence to make sure it had all the information and that it was accurate. They needed time to meet with auditors and carefully prepare the press release.
3. Duty to Correct/Update
   1. Obviously, if a disclosure is in fact misleading when made, and the speaker thereafter learns of this, there is a duty to correct it.
   2. There may be a duty to update if a prior disclosure “becomes materially misleading in light of subsequent events”. Backman v. Polaroid Corp. (1st Cir. 1990)
      1. The court requires special circumstances, meaning that the comment has to have “forward intent and connotation upon which parties may be expected to rely”.
      2. In this case, Polaroid had stated in its Third Quarter Report that its earnings “continue to reflect substantial expenses with Polavision”.
      3. This statement was correct at the time and remained correct thereafter. This statement was just a simple statement of fact and there was nothing forward looking about it.
      4. Not like in Weiner v. Quaker Oats, in which Quaker had announced its debt-to-total capitalization ratio “for the future” to be at 59%, which later became much higher.
4. Duty to disclose alternative approaches
   1. When a corporation is pursuing a specific business goal and announces that goal as well as an intended approach for reaching it, it may come under an obligation to disclose other approaches to reaching the goal when those approaches are under active and serious consideration. In re Time Warner Securities Litigation.
5. Duty to make forward projections
   1. SEC does not require a corporation to project future earnings.
   2. However, the SEC requires that the MD&A must “identify any known trends or uncertainties…that the registrant reasonably expects will have a material favorable or unfavorable impact” on its results of operations or liquidity.
6. Duty to correct rumors and statements by third parties
   1. The case law appears to be that a company has no duty to correct or verify rumors in the marketplace unless those rumors can be attributed to the company. In re Time Warner Securities Litigation.
   2. The court believes this information is never material because “investors tend to discount information in newspaper articles when the author is unable to cite specific, attributable information from the company”.

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