1)Duty to Employer--using the misappropriation theory, criminal liability under rule 10b-5 has been imposed where an employee trades on info used in violation of the employee’s fiduciary duty to his employer. An employee’s duty to “abstain or disclose” with respect to his ER does NOT extend to the general public. However, the Insider Trading and Securities Fraud Enforcement Act of 1988 makes any person who violates rule 10b-5 by trading while in possession of material, nonpublic info liable to any person who, contemporaneously to the transaction, purchased or sold securities of the same class. Liability is limited to the defendant’s profit or avoided loss.
2)Mail and wire fraud--the application of the federal mail and wire fraud statute to this situation lessens the importance of the misappropriation theory in imposing criminal liability under rule 10b-5.
3)Special rule for tender offers--once substantial steps toward making a tender offer have begun, it is a fraudulent, deceptive, or manipulative act for a person possessing material information about the tender offer to purchase or sell any of the target’s stock, if that person knows that the info is nonpublic and has been acquired from the bidder, the target, or someone acting on the bidder’s or the target’s behalf.
d)”Disclose or Abstain”--nondisclosure by a person with a duty to disclose violates rule 10b-5 only if he trades (Cady rule)
8.LIABILITY OF NONTRADING PERSONS FOR MISREPRESENTATION--a nontrading corp or person who makes a misrepresentation that could cause reasonable investors to rely thereon in the purchase or sale of securities is liable under rule 10b-5, provided the scienter requirement is satisfied.
9.LIABILITY OF NONTRADING CORPORATION FOR NONDISCLOSURE--the basic principle is “disclose or abstain.” Thus, a nontrading corp is generally not liable under rule 10b-5 for nondisclosure of material facts.
a)Exceptions--a corp has a duty to:
1)Correct misleading statements (even if unintentional);
2)Update statements that have become materially misleading by subsequent events; 3)Correct material errors in statements by others (e.g, analyst’s report) about the corp, but only if the corp was involved in the preparation of the statements; and
4)Correct inaccurate rumors resulting from leaks by the corp or its agents.
10.TIPPEE AND TIPPER LIABILITY--a person, not an insider, who trades on info received from an insider is a tippee and may be liable under rule 10b-5 if he received info through an insider who breached fiduciary duty in giving the info, AND the tippee knew or should have known of the breach (Dirks)
a)Breach of Insider’s Fiduciary Duty--whether an insider’s fiduciary duty was breached depends largely on whether the insider communicated the info to realize the gain or advantage. Accordingly, tips to friends or relatives and tips that are a quid pro quo for a past or future benefit from the tippee result in fiduciary breach. Note that if a tippee is liable, so is the tipper.
11.”TEMPORARY INSIDERS”--corporate info legitimately revealed to a professional or consultant (e.g., accountant) working for the corp may make this person a fiduciary of corp
12.AIDERS AND ABETTORS--liability cannot be imposed solely because a person aided and abetted the violation of the rule.
13.APPLICATION OF RULE 10B-5 TO BREACH OF FIDUCIARY DUTY BY DIRECTORS, OFFICERS, AND CONTROLLING SHAREHOLDERS.
a)Ordinary Mismanagement--a breach of fiduciary duty not involving misrepresentation, nondisclosure, or manipulation does NOT violate rule 10b-5;
b)Misrepresentation or Nondisclosure--if this is the basis of a purchase from or sale to the corp by a dir or officer, the corp can sue the fiduciary under rule 10b-5 and also for breach of fiduciary duty. If the corp doesn’t sue, a minority sh can maintain a derivative suit on the corporations behalf.
c)Purchase or Sale By Controlling Shareholder--when a corp purchases stock from or sells stock to a controlling sh at an unfair price, and material facts aren’t disclosed to minority shs, a derivative action may lie if the nondisclosure caused a loss to the minority shs. The plaintiffs must establish causation by showing that an effective state remedy (e.g., injunction) was foregone because of nondisclosure.
14.BLUE CHIP RULE--PRIVATE PLAINTIFF--a plaintiff can bring a private cause of action only if he actually purchased or sold the relevant securities. “Sale” includes an exchange of stock for assets, mergers and liquidations, contracts to sell stock, and pledges. The SEC can bring action under rule 10b-5 even though it has neither purchased or sold securities.
15.DEFENSES
a)Due Diligence--if a plaintiff’s reliance on a misrepresentation or omitted fact could have been prevented by his exercise of due diligence, recovery may be barred. Mere negligence does NOT constitute a lack of due diligence, although a plaintiff’s intentional misconduct and his own recklessness (if D was merely reckless) will bar recovery.
b)In pari delicto--a private suit for damages under rule 10b-5 will be barred if:
1)The plaintiff bears substantially equal responsibility for the violations, AND
2)Preclusion of the suit would not significantly interfere with the enforcement of securities law.
16.REMEDIES
a)Out-of-pocket Damages--this is the difference between the price paid for stock and its actual value.
1)Compare--benefit-of-the-bargain damages--these are measured by the value of the stock as it really is and the value it would have had if a misrepresentation had been true.
2)Standard measure of conventional damages--out-of-pocket damages is the standard measure in private actions under rule 10b-5; benefit-of-the-bargain damages are usually not granted.
b)Restitutionary Relief--this may be sought instead of conventional damages:
1)Rescission--returns the parties to their status quo before the transaction
2)Rescissionary or Restitutionary damages--money equivalent of rescission
3)Difference between conventional damages and Restitutionary relief--out-of-pocket damages are based on the P’s loss, while Restitutionary relief is based on the D’s wrongful gain. Rescission or Rescissionary damages may be attractive remedies when the value of the stock changed radically after the transaction. However, Restitutionary relief is usually unavailable in cases involving publicly held stock.
c)Remedies Available to the Government--although the SEC cannot sue for damages, it can pursue several remedies including special monetary remedies:
1)Injunctive Relief--the SEC often seeks injunctive relief accompanied with a request for disgorgement of profits or other payments that can be subject to criminal sanctions (fines and jail sentences) and civil penalties (up to three times the profit gained or loss avoided).
17.JURISDICTION, VENUE, AND SERVICE OF PROCESS--suits under 10b-5 are based on the 1934 Act, and exclusive jurisdiction is in the federal district courts. State claims arising out of the same transactions may be joined with the federal claim under the supplemental jurisdiction doctrine. Venue can be wherever any act or transaction constituting a violation occurred, or where the D is found or transacts business. Process can be served where the D can be found or where he lives.
18.STATUTE OF LIMITATIONS--the 1934 Act contains no SOL; however, the SCt has held that private actions must be brought within one year after discovery of the relevant facts and within three years following accrual of the cause of action. The tolling doctrine is inapplicable.
a)Exceptions--the time limitations don’t apply to all rule 10b-5 private actions, e.g., SEC limitations period of five years for private suits by contemporaneous traders against purchasers or sellers who violate rules regarding trades while in possession of material, nonpublic information. Further, the SEC is not subject to any limitations period in civil enforcement actions.
D.SECTION 16 OF THE 1934 ACT--Section 16 concerns purchases followed by sales, or sales followed by purchases, by certain insiders, within a six-month period.
1.FIRMS AND SECURITIES AFFECTED UNDER SECTION 16--Section 16 applies to those firms and securities that must be registered under section 12 of the 1934 act.
a)Reason--16(a) references registered securities under S12; S12(a) and 12(g) create the registration requirement for securities; S12(g)creates an asset ($1 mln total) and distribution (500 to 700 depending on timing); 16(b) references “such” officers, etc., which refers to sub(a)
b)Note--trading in all of a corp’s equity securities is subject to section 16 if any class of its securities is registered under section 12.
2.DISCLOSURE REQUIREMENT--Section 16(a) requires every beneficial owner of more than 10% of the registered stock and directors and officers of the issuing corp to file periodic reports with the SEC showing their holdings and any changes in their holdings.
a)Who is an Officer (16a-1f)--issuer’s president, principal financial director, principal accounting officer, any vice-president of the issuer in charge of a principal business unit, any other officer who performs similar policy-making functions for the issuer.
3.LIABILITY--to prevent the unfair use of information, section 16(b) allows a corp to recover profits made by an officer, dir, or more-than-10% beneficial owner on the purchase and sale or sale and purchase of its securities within a six-month period.
