PARTNERSHIPS, CORPORATIONS AND THE VARIANTS PROF. BRUCE MCCANN SPRING SEMESTER LECTURE 12 INSIDER TRADING PP Business Organizations Lectures

10b-5 Lec. 12 Sem 2, pp Corps Prof. McCann "Rule 10b-5: Employment of Manipulative and Deceptive Practices": It shall be unlawful for any person, directly or indirectly, by the use of any means or instrumentality of interstate commerce, or of the mails or of any facility of any national securities exchange, (a) To employ any device, scheme, or artifice to defraud, (b) To make any untrue statement of a material fact or to omit to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading, or (c) To engage in any act, practice, or course of business which operates or would operate as a fraud or deceit upon any person, in connection with the purchase or sale of any security."

The Elements Lec. 12 Sem 2, pp Corps Prof. McCann Material misrepresentation or nondisclosure Scienter A connection between the misrepresentation and the purchase or sale of a security Reliance Economic Loss Loss Causation (a “causal relationship” between the misrep and the loss

Sub-Issues in 10b-5 Cases Lec. 12 Sem 2, pp Corps Prof. McCann Fault  Simple negligence is insufficient to suport an action for civil damages. There must be an intent to deceive, defraud or manipulate. Ernst and Ernst v Hochfelder  Recklessness will suffice to establish requisite scienter.

Sub-Issues in 10b-5 Cases Lec. 12 Sem 2, pp Corps Prof. McCann Who Is Subject to 10b-5 Constraint?  Absent a relationship between a purchaser of stock and the seller, there is no duty to disclose information acquired by the purchaser under 10(b).  However, that relationship can be found to exist where purchaser works for, say, printer employed by seller. (Misappropriation)  Duty likewise where purchaser is insider or fiduciary of seller  But, SEC can find violation if anyone was owed a duty by the purchaser, even if a particular plaintiff cannot succeed. Materia (SEC prosecution against printer’s employee).

Sub-Issues in 10b-5 Cases Lec. 12 Sem 2, pp Corps Prof. McCann Tippees/ Aiders and Abettors  Where insider who made disclosure did so without violating fiduciary duty, a tippee who passes the disclosure on is not liable under 10(b)-5  Dirks v SEC: Source of information was insider who disclosed it in the process of trying to investigate wrongdoing.  Test: Did the insider personally gain?

Sub-Issues in 10b-5 Cases Lec. 12 Sem 2, pp Corps Prof. McCann Tippees/ Aiders and Abettors Congress did not extend the reach of 10(b)-5 to aiders and abettors and the courts decline to do so as well.

The Elements Lec. 12 Sem 2, pp Corps Prof. McCann Material misrepresentation or nondisclosure Scienter A connection between the misrepresentation and the purchase or sale of a security Reliance Economic Loss Loss Causation (a “causal relationship” between the misrep and the loss

Loss Causation and Damages Lec. 12 Sem 2, pp Corps Prof. McCann Fact price is inflated (“fraud on market” test) is not sufficient to prove the misrepresentation caused the loss.  At the moment of purchase the stock is worth what was paid, so no loss.  The inflated price may, but may not, lead to the later loss when the stock is sold for a lower price.  Dura Pharmaceuticals, Inc. v. Broudo (reversing 9 th circuit test that plaintiff sufficiently alleged causation between the loss and the misrepresentation for 10(b)-5 purposes by alleging the price paid was inflated)

Calculation of Damages Lec. 12 Sem 2, pp Corps Prof. McCann Disgorgement Measure:  Plaintiff may recover post-purchase decline in value up to reasonable time after purchase, limited by the total gain enjoyed by the tippee as a result of trading on the inside information.  Where multiple plaintiffs, recover pro rata from the tippee. Subsequently, Sec. 20A provided for treble damages and other disincentives in SEC prosecutions.