The Martha Stewart Case Discussion and Responses

Chapter 41 Discussion

Review the Case Opener (“The Martha Stewart Case”) on page 284 of your text.

Do you think that Martha Stewart violated federal securities law? Why or why not? Your legal analysis aside, discuss whether you think it is fair to charge people situated similarly to Martha Stewart’s position in this case with violations of securities law.

YOUR RESPONSE SHOULD REFLECT YOUR INDEPENDENT THOUGHT AND CONCLUSIONS AND NOT MERELY RECITE THE COURT’S FINDINGS.

INSTRUCTIONS

Make an initial post that is responsive to the above prompt and all questions posed in it.

Your post must be between 200-500 words.

a.Initial response to discussion question(s)

b.Two replies to other students’ posting

chapter video

8/4/2018
Chapter 41
Corporations: Securities and Investor
Protection
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
Overview
• LO41-1: What is a security?
• LO41-2: What requirements are imposed
by the Securities Act of 1933?
• LO41-3: How does the Securities Exchange
Act of 1934 regulate the trading of
securities?
• LO41-4: How are investment companies
regulated?
• LO41-5: How do states regulate securities?
41-2
Chapter 41 Hypothetical Case 1
• As this chapter indicates, although the Securities and Exchange Commission
(SEC) requires the registration of securities, the SEC does not approve these
securities. In other words, the SEC does not make any judgment about the worth
of securities. Instead, it simply enforces the requirement that issuers provide
certain information to potential buyers, including: (1) a description of the
securities offered for sale; (2) an explanation of how proceeds from the sale of
the securities will be used; (3) a description of the registrant’s business and
properties; (4) information about the management of the company; (5) a
description of any pending lawsuits in which the registrant is involved; and (6)
financial statements certified by an independent public accountant.
• As the federal administrative agency with primary responsibility for regulating
the United States securities market, should the Securities and Exchange
Commission formulate a judgment regarding the worth of soon-to-be-issued
securities and inform potential investors of that judgment? Does the SEC have an
ethical obligation to potential investors to make and publicize such valuation
judgments?
41-3
1
8/4/2018
Chapter 41 Hypothetical Case 2
• Thomas Abramson is a quality control manager for Capitol-IZE
Pharmaceutical Company, Inc. The company is headquartered and has its
principal production facility in Indianapolis, Indiana. For several years,
Capitol-IZE Pharmaceutical has been engaged in the research and
development of a new cancer drug, Izerion. As part of the federal regulatory
procedure for mass-marketing a new drug, Capitol-IZE Pharmaceutical
applied to the Food and Drug Administration (FDA) for final approval of
Izerion.
• Yesterday, Abramson’s supervisor informed him in somber fashion that the
FDA had rejected the company’s application for final approval of Izerion.
Apparently, the FDA was concerned about serious side effects that
manifested during the drug’s clinical trials. Abramson’s supervisor further
advised him that next Monday Capitol-IZE Pharmaceutical is scheduled to go
public with a press release concerning the FDA’s rejection of Izerion.
41-4
Chapter 41 Hypothetical Case 2
(cont’d)
• Abramson is frantic. He owns approximately 6,000 shares of Capitol-IZE
Pharmaceutical stock, and he knows that news of the FDA’s rejection of Izerion will be
disastrous to the company, its employees, and its shareholders. Capitol-IZE
Pharmaceutical stock is currently valued at $47.50 per share, and news of the FDA’s
disapproval of Izerion will likely drive the stock down to one-half of its current value.
Abramson quickly runs the numbers on his calculator. A reduction of 50% of the
stock’s value would represent a personal loss of $142,500. Abramson’s Capitol-IZE
Pharmaceutical stock is his only retirement plan, aside from a modest pension he will
receive from the company (assuming the company survives the announcement).
Abramson has a plan. Today, he will instruct his financial planner to immediately sell
all 6,000 shares of his Capitol-IZE Pharmaceutical Company, Inc. stock. Abramson
rationalizes his decision by assuring himself that anyone else in his position would do
the same thing.
• Is Thomas Abramson’s plan legal? Is it ethical?
41-5
Securities and the SEC
• Security: Investment in a common enterprise
with the reasonable expectation of profit
gained predominantly from others’ efforts
• Securities and Exchange Commission: Created
in 1934 to:
• Enforce securities laws
• Interpret provisions of securities acts
• Regulate the trade of securities
• Regulate the activities of securities brokers,
dealers, and advisers
41-6
2
8/4/2018
Expansion of SEC Powers in the
1990s
• Securities Enforcement Remedies and
Penny Stock Reform Act of 1990
• Market Reform Act of 1990
• Securities Acts Amendments of 1990
• National Securities Markets Improvement
Act of 1996
• Sarbanes-Oxley Act of 2002
41-7
Securities Act of 1933 Requirements:
Registration Statement
• Securities Act of 1933: Passed to legitimize
security transactions by requiring registration of
securities
• Registration statement is document containing:
•
•
•
•
•
•
Description of securities offered
Explanation of how proceeds from sale will be used
Description of registrant’s business and properties
Information about management of company
Description of pending lawsuits
Certified financial statements
41-8
Securities Act of 1933: Terminology,
Rules, and Procedures
• Prospectus: Written document similar to registration statement, used as a selling
tool to attract potential investors
• Periods of the registration statement and prospectus filing process:
• Prefiling period
• Waiting period
• Posteffective period
• Exempt transactions: Securities exempt from standard SEC registration
requirements
• Limited offers: Involve small amounts of money, or are offered only to
sophisticated investors
• Private placement exemption: Exempts private offerings of securities
• Rule 505: States that private offerings may not exceed $5 million in a 12-month period, and
firms do not have to believe that investors have a reasonable ability to evaluate risk
• Rule 504: Exempts noninvestment firms that offer no more that $1 million in securities in a
12-month period
• Section 4(6): Exempts securities offered only to accredited investors for amount less than $5
million
41-9
3
8/4/2018
Securities Act of 1933: Terminology,
Rules, and Procedures (cont’d)
• Intrastate issues: Exempt local investors in local
businesses
• Resales of securities: Exempt transactions by any
person other than an issuer, underwriter, or dealer
• Restricted securities: Securities acquired under Rule
505, 506, or Section 4(6) that must be registered for
resale, unless investor follows Rule 144 or 144(a)
• Violations may result in:
• Administrative action
• Injunctive action
• Criminal prosecution
41-10
Securities Exchange Act of 1934
• Section 10(b): Prohibits use of manipulative and
deceptive devices to bypass SEC rules
• Insider trading: Trading in which company
employee or executive uses material inside
information to make profit
• Misappropriation theory: Individual who wrongly
acquires and uses inside information for profit is
liable for insider trading
41-11
Securities Exchange Act of 1934:
Terms, Rules, and Procedures
• Tipper/tippee theory: Individual who receives
material inside information as a result of insider’s
breach of duty is guilty of insider trading
• Statutory insiders: Certain stockholders, executive
officers, and directors who must file reports
detailing their ownership and trading of the
corporation’s securities
• Short-swing profits: Profits made from sale of
company stock within any six-month period by
statutory insider; per Section 16(b), these profits
must be returned to company
41-12
4
8/4/2018
Securities Exchange Act of 1934:
Terms, Rules, and Procedures (cont’d)
• Proxy: Document that authorizes an individual to
vote shareholder’s share of stocks at a shareholders’
meeting
• Proxy solicitation: Process of obtaining authority to
vote on behalf of shareholder
• Violations of Securities Exchange Act of 1934 may
result in:
• Criminal penalties
• Civil penalties
• Suits against those involved in insider trading under
Insider Trading Sanctions Act of 1984
41-13
State Securities Regulation
• Blue-sky laws: Regulate the offering and
sale of securities within the state only
• Some laws exempt from federal securities
regulation may be subject to state laws
• Often similar to federal securities laws
• Uniform Securities Act: Most states have
adopted
41-14
Chapter 41 Hypothetical Case 3
• Although the Securities and Exchange Commission has existed as a
federal administrative agency for over 70 years (the Commission was
created in 1934), some critics question the need for its continued
existence, or alternatively argue for significant deregulation of stock
trades. According to critics, there is arguably no need for significant
federal regulation of publicly-traded securities, since market conditions
dictate legitimacy and honesty in securities transactions; after all, for
how long could a corporation exist if it does not strive to ensure the
integrity of its stock?
• How do you respond to this line of reasoning, that the free market will
dictate fair and honest stock trades? In your answer, consider the history
and mission of the Securities and Exchange Commission.
Reference: About the SEC: What We Do
41-15
5
8/4/2018
Chapter 41 Hypothetical Case 4
• A new tech start-up, Tolumetrix, is planning to go public in an initial public offering
(IPO). One of the company’s executives, Richard Columbus, is charged with preparing
the company’s registration statement and prospectus, which are required.
Columbus is unfamiliar with the process of creating and filing these documents and
with securities in general; a programmer by trade, he is new to the entire process of
running a successful company. He decides to use the documents provided by a similar
company as a template.
Columbus files the forms to the SEC and immediately begins making oral offers to sell
the company’s stock. He sends a copy of the prospectus identical to the one that has
been submitted to the SEC. He does not send a follow-up version of the prospectus
after many changes are requested and made and the final approval has come from
the SEC.
• Has Columbus—and Tolumetrix—violated the 1933 Securities Act? Explain your
answer.
41-16
6