Corporate Finance Law and Business Planning: Liability and Compliance
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L541: Corporate Finance Law and Business Planning
Prof. Karen E. Woody
Assistant Professor of Business Law & Ethics
Fall 2016
•Section 11 of the Securities Act of 1933
-An underwriter is liable for errors in the entire registration statement
-As an expert, an auditor is liable only for that part of a registration statement for which the auditor has issued an opinion about the financial statements
•Auditors (experts) may raise due diligence defense
-Compliance with GAAS and GAAP required
•Underwriters may also raise a due diligence defense:
-For parts of registration statement contributed by experts, underwriter may rely on expert opinion
-For remainder, the underwriter must prove a reasonable investigation, after which s/he had a reasonable belief there were no misstatements or omissions of material fact
•Section 12(a)(2) of the Securities Act of 1933
-Direct contact with buyer is required, thus merely performing professional services is not enough
•Under Section 17(a) of the Securities Act of 1933
•Section 18 of the 1934 Securities Exchange Act
-Purchaser or seller of a security must prove reliance on the defective document
•Rule 10b–5
-Purchaser or seller must prove reliance, but in omission cases, reliance may be inferred from materiality
-Defendant must have acted with scienter
-No scienter found in Ferris, Baker Watts, Inc. v. Ernst & Young, LLP
•The Act imposes significant public duties on independent auditors that audit financial statements of public companies
•However, the Act limits the liability of most professionals to the amount of an investor’s loss for which the defendant is responsible
•Section 404 requires public issuers to include in their annual reports an “internal control report”
-www.aicpa.org/sarbanes/index.asp
•Auditors must attest to management’s assessment of internal controls
•Authorizes SEC to issue point-of-sale disclosure rules
•Authorizes the SEC to impose a fiduciary duty on broker-dealers and investment advisers
•1933 Act imposes criminal liability for willful violations
•1934 Act imposes criminal penalties for willful violations
Insider Trading
•Rule 10b–5 prohibits a person with inside information from using the information when trading securities
-Insider: anyone with confidential corporate information for a corporate purpose
-Disclose-or-refrain rule: insider must either disclose the information before trading or refrain from trading
-Tippees receive inside information
Dirks v. SEC
•Facts:
-Dirks obtained nonpublic information from former officer of Equity Funding (EF)
-Finding evidence of wrongdoing, Dirks told clients, who sold their EF securities
-EF share price dropped dramatically and Dirks voluntarily presented information to the SEC, which then brought action against EF
-SEC brought action against Dirks for a Rule 10b-5 violation, but censured him since he played a role in bringing the fraud to light; Dirks appealed
•Legal Reasoning & Supreme Court Holding:
-No duty to disclose if person trading on inside information was not firm’s agent or fiduciary
-Unless insider-tippers breached their duty to shareholders by disclosing to Dirks, he breached no duty when he passed the information along
-Tippers, motivated by a desire to expose fraud, did not breach their duty to shareholders, thus no derivative breach by Dirks
-Reversed in favor of Dirks
•Rule 10b–5 liability attaches to anyone who trades in securities for personal profit using confidential information misappropriated by a breach of fiduciary duty owed to source of the information (misappropriation theory)
•Rule 10b–5 prohibits anyone from making a misstatement or omission of material fact in connection with securities purchase or sale
-Purchaser or seller must prove reliance, but in omission cases, reliance may be inferred from materiality
-Defendant must have acted with scienter
•Reg. FD (fair disclosure) states that when an issuer or person acting for the issuer discloses material nonpublic information to securities market professionals and holders of the issuer’s securities, it must make public disclosure of that information
-File or furnish Form 8-K or use other method designed to effect broad, nonselective disclosure to the public
•To comply with Reg. FD, companies should:
-Establish clear rules for content of information that may be disclosed
-Require previews of any material disclosure by a qualified team of executives (e.g., legal counsel and an investor relations officer)
-Use several mass communications outlets: press releases, submissions to SEC, Internet based sound and video presentations
-Adopt procedures for appropriate corrective action after a selective disclosure occurs
•Section 32:
-Individuals may be fined up to $5 million and imprisoned up to 20 years for willful violations
-Businesses may be fined up to $25 million
•FCPA makes it a crime for any American firm to offer, promise, or make payments or gifts of anything of value to foreign officials and certain others in order to influence a governmental decision
•FCPA also establishes record-keeping and internal control requirements for firms subject to the periodic disclosure provisions of the Securities Exchange Act of 1934
The FCPA imposes three distinct requirements:
•Anti-Bribery: Prohibits giving, offering, or promising anything of value, directly or indirectly, to a foreign official for the corrupt purpose of obtaining or retaining business.
•Books and Records: Public companies must keep books and records in reasonable detail that fairly and accurately reflect the transactions and circumstances of the company.
•Internal Controls: Public companies must devise and maintain a system of internal controls that provides reasonable assurance of accurate books and records and GAAP compliant financial statements.
Who is subject to the FCPA?
•All U.S. companies
•All U.S. citizens and residents (anywhere in the world, regardless of employer)
•All public companies (U.S. and foreign)
•Foreign companies with a presence in the U.S.
•Non-resident aliens and foreign entities that act or use U.S. mails or wires while in the United States
•Officers, directors, employees or agents, in the U.S. or abroad, of any of the above
-U.S. companies can be liable for the acts of foreign subsidiaries, JV partners, and other agents
•The Anti-Bribery provisions prohibit:
-Giving or offering or promising or authorizing
-Directly or indirectly
-Anything of value
-To any foreign official
-Corruptly
-In order to obtain or retain business, or otherwise gain an unfair advantage
•Why does this matter?
•Criminal and civil fines / imposition of an independent monitor
•Parallel law enforcement and regulatory actions (e.g., OFAC, IRS)
•Criminal actions against executives and employees
•Civil litigation (e.g., Wal-Mart – shareholder class action; Alcoa Bahrain – suit by competitor alleging contract awarded on corrupt basis)