Florida International University Insider Trading Case Study

Debate This:

Insider Trading

Chapter 36, p. 865

Dale Emerson served as the chief financial officer for Reliant Electric Company, a distributor of electricity serving portions of Montana and North Dakota. Reliant was in the final stages of planning a takeover of Dakota Gasworks, Inc., a natural gas distributor that operated solely within North Dakota. On a weekend fishing trip with his uncle, Ernest Wallace, Emerson mentioned that he had been putting in a lot of extra hours at the office planning a takeover of Dakota Gasworks. When he returned from the fishing trip, Wallace purchased $20,000 worth of Reliant stock. Three weeks later, Reliant made a tender offer to Dakota Gasworks stockholders and purchased 57 percent of Dakota Gasworks stock. Over the next two weeks, the price of Reliant stock rose 72 percent before leveling out. Wallace sold his Reliant stock for a gross profit of $14,400. Using the information presented in the chapter, answer the following questions.

1. Would registration with the SEC be required for Dakota Gasworks securities? Why or why not?
2. Did Emerson violate Section 10(b) of the Securities Exchange Act of 1934 and SEC Rule 10b-5? Why or why not?
3. What theory or theories might a court use to hold Wallace liable for insider trading?
4. Under the Sarbanes-Oxley Act, who would be required to certify the accuracy of the financial statements Reliant filed with the SEC

Debate This:

Insider trading should be legalize

865
CHAPTER 36: Investor Protection, Insider Trading, and Corporate Governance
Certification and Monitoring Requirements Section 906 requires that chief executive
officers (CEOs) and chief financial officers (CFOs) certify that the information in the corporate financial statements “fairly represents in all material respects, the financial conditions and results of operations of the issuer.” This requirement makes officers directly
accountable for the accuracy of their financial reporting and avoids any “ignorance defense”
if shortcomings are later discovered.
The act also includes requirements to improve directors’ monitoring of officers’ activities.
All members of the corporate audit committee for public companies must be outside directors. The audit committee must have a written charter that sets out its duties and provides
for performance appraisal. At least one “financial expert” must serve on the audit committee,
which must hold executive meetings without company officers present. In addition to reviewing the internal controls, the committee also monitors the actions of the outside auditor.
Learning Objective 4
What certification
requirements does the
Sarbanes-Oxley Act impose
on corporate executives?
Practice and Review
Dale Emerson served as the chief financial officer for Reliant Electric Company, a distributor of
electricity serving portions of Montana and North Dakota. Reliant was in the final stages of planning
a takeover of Dakota Gasworks, Inc., a natural gas distributor that operated solely within North
Dakota. On a weekend fishing trip with his uncle, Ernest Wallace, Emerson mentioned that he had
been putting in a lot of extra hours at the office planning a takeover of Dakota Gasworks. When he
returned from the fishing trip, Wallace purchased $20,000 worth of Reliant stock. Three weeks later,
Reliant made a tender offer to Dakota Gasworks stockholders and purchased 57 percent of Dakota
Gasworks stock. Over the next two weeks, the price of Reliant stock rose 72 percent before leveling
out. Wallace sold his Reliant stock for a gross profit of $14,400. Using the information presented in
the chapter, answer the following questions.
1. Would registration with the SEC be required for Dakota Gasworks securities? Why or why not?
2. Did Emerson violate Section 10(b) of the Securities Exchange Act of 1934 and SEC Rule 10b-5?
Why or why not?
3. What theory or theories might a court use to hold Wallace liable for insider trading?
4. Under the Sarbanes-Oxley Act, who would be required to certify the accuracy of the financial
statements Reliant filed with the SEC?
Debate This
Insider trading should be legalized.
Key Terms
accredited investor 847
corporate governance 861
free-writing prospectus 844
insider trading 852
investment company 848
30301_ch36_hr_841-870.indd 865
investment contract 842
mutual fund 848
prospectus 843
SEC Rule 10b-5 852
securities 841
short-swing profits 855
stock option 862
tippee 854
8/30/18 1:55 PM
866
UNIT FIVE: Business Organizations
Chapter Summary: Investor Protection, Insider Trading, and Corporate Governance
Securities Act
of 1933
Prohibits fraud and stabilizes the securities industry by requiring disclosure of all essential information relating
to the issuance of securities to the investing public.
1. Registration requirements—Securities, unless exempt, must be registered with the SEC before being
offered to the public.
a. The registration statement must include detailed financial information about the securities being offered
for sale; the issuing corporation’s properties, business, and management; the intended use of the
proceeds of the sale of the securities being issued; and any pending lawsuits or special risk factors.
b. The issuer must provide investors with a prospectus that describes the security being sold, the financial
operations of the issuing corporation, and the investment or risk attaching to the security.
2. Exemptions—The SEC has exempted certain offerings from the requirements of the Securities Act of 1933.
Exemptions may be determined on the basis of the size of the issue, whether the offering is private or public,
and whether advertising is involved.
Securities
Exchange Act
of 1934
Provides for the regulation and registration of securities exchanges, brokers, dealers, and national securities
associations. Maintains a continuous disclosure system for publicly held corporations to enable the SEC to
regulate subsequent trading. Applies to companies that have assets in excess of $10 million and either two
thousand or more shareholders or five hundred or more shareholders who are unaccredited (Section 12
companies).
1. SEC Rule 10b-5 [under Section 10(b) of the 1934 act]—This rule prohibits the commission of fraud in
connection with the purchase or sale of any security.
a. Applies to almost all trading of securities—a firm’s securities do not have to be registered under the 1933
act for the 1934 act to apply.
b. Applies to insider trading by corporate officers, directors, majority shareholders, and any persons
receiving inside information (information not available to the public) who base their trading on this
information. Liability for insider trading may be based on the tipper/tippee or the misappropriation theory.
c. May be violated by omitting or misrepresenting “material facts” related to the purchase or sale of a
security.
d. Liability for violations can be civil or criminal.
2. Insider trading [under Section 16(b) of the 1934 act]—To prevent corporate insiders from taking advantage
of inside information, the 1934 act requires officers, directors, and shareholders owning 10 percent or
more of the issued stock of a corporation to turn over to the corporation all short-term profits (called
short-swing profits) realized from the purchase and sale or sale and purchase of corporate stock within
any six-month period.
3. Regulation of proxies—Section 14(a) of the 1934 act regulates the solicitation of proxies from shareholders
of Section 12 companies.
4. Online securities fraud—The SEC today faces the problem of enforcing the antifraud provisions of the
securities laws in the online environment. Internet-related forms of securities fraud include fraudulent
newsletters and social media posts.
State Securities
Laws
Regulate the offer and sale of securities within state borders (also known as blue sky laws). States regulate
securities concurrently with the federal government. The Uniform Securities Act is designed to promote
coordination of state and federal securities regulation and enforcement efforts.
Corporate
Governance
Involves a set of policies specifying the rights and responsibilities of the various participants in a corporation
and spelling out the rules and procedures for making decisions on corporate affairs. Corporate governance
is necessary in large corporations because corporate ownership (by the shareholders) is separated from
corporate control (by officers and managers). This separation of corporate ownership and control can often
result in conflicting interests. Corporate governance standards address such issues.
1. Aligning the interests of officers and shareholders—Some corporations attempt to align the financial
interests of their officers with those of their shareholders by providing the officers with stock options.
2. Sarbanes-Oxley Act—This act attempts to increase corporate accountability by imposing strict disclosure
requirements and harsh penalties for violations of securities laws.
30301_ch36_hr_841-870.indd 866
9/3/18 11:54 AM