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Presentation 1 - University at Albany Powered By Docstoc
					Internet Transactions and Internet Fraud
Acc680                                               Jim Nellegar


         Is the Internet Participating Securities Fraud?:
              Harsh Realities in the Public Domain


              The Future of Corporate Disclosure:
         The Internet, Securities Fraud, and Rule 10b-5


         Legal Aspects of Internet Securities Transactions
           Tulane Law Review (1998)

Is the Internet Participating in Securities Fraud?:
      Harsh Realities in the Public Domain


                      Will Morrow
                     B.A Vanderbilt,
              M.B.A. University of Alabama,
                 J.D. Tulane Law School
  Is the Internet Participating Securities Fraud?:
          Harsh Realities in the Public Domain

I. Introduction
  • Whirlpool Financial Corp. v. G.N. Holdings, Inc. 
  • Estoppel (Define)
  • Rule 10b and 10b-5 of SEC Act of 1934 (1 year time limitation)
  • Internet’s role as a procedural bar to fraud complaints
Is the Internet Participating Securities Fraud?:
       Harsh Realities in the Public Domain

• Focus: Cause of action for fraud & Statutory time bars


• U.S. Court of Appeals Seventh Circuit Court


• Internet now part of “reasonably diligent” search expectation

• Result: Praise and criticism
 Is the Internet Participating Securities Fraud?:
        Harsh Realities in the Public Domain

II. Old Schemes on a New Channel
  • New channel comes with no “v” chip
  • Few other control on access to and sources of information
  • Risk #1: Posting misleading information (direct)
  • Risk #2: “Pump & dump” (indirect)
  • SEC is performing limited monitoring, complaints page.
  • SEC acknowledges e-info = “junk mail”, need ind. verif.
  • Also: constructive notice is federally mandated info.
  Is the Internet Participating Securities Fraud?:
          Harsh Realities in the Public Domain

III. Internet as a Procedural Bar to Victim’s Recovery
      •  Internet as a source of notice presents risks to non-users
      • Date suit accrues is at issue: plaintiff has one year
      • Courts will not tolerate “leisurely” discovery
      • Sans material misrepresentation of defendant
      • “Reasonable investor” standard imputes information
      • e.g., Forecast results
  Is the Internet Participating Securities Fraud?:
          Harsh Realities in the Public Domain
III. Internet as a Procedural Bar to Victim’s Recovery (cont’d)
      • Whirlpool v. G.N. Holdings, Inc.
      • Cause of action was for:
       - Non-disclosure of significant adverse industry trends/laws
         (rejected)
       - Forecast v. actual results
      • Two issues:
        - Internet as a trigger for inquiry notice
       - Preclusion of equitable estoppel

      • Gave rise to, but did not resolve, Internet issues.
 Is the Internet Participating Securities Fraud?:
        Harsh Realities in the Public Domain

III. Internet as a Procedural Bar to Victim’s Recovery (cont’d)
     • Whirlpool v. G.N. Holdings, Inc.
     • Information of interest to Whirlpool was on internet
     • Thus, knowledge imputed (created broad brush approach).
     • Inclusion of Internet laudable, more direction needed
     • Differences between Internet and other sources not defined
     • e.g., novelty of technology, temporary/transient nature:
       - Standard publications v. proliferation of newsgroups
       - Reliability of sources and facts (vs. known and reputable)
 Is the Internet Participating Securities Fraud?:
        Harsh Realities in the Public Domain

IV. Conclusion
    • Application of Internet to procedural issues = less
      protection for consumers
    • Actual notice would alleviate issue (Supreme Court’s
      standard for securities fraud
    • Otherwise, Courts have not addressed key issues…
    • While SEC rejects web-based info. Not independently verified
    • No archival systems to address transient nature of web
    • Key is for court not to accept internet based info. W/O inquiry
    • Each source (used a procedural bar) should be evaluated
    The Future of Corporate Disclosure:
The Internet, Securities Fraud and Rule 10b-5
     Emory University School of Law (1998)

The Future of Corporate Disclosure: The Internet,
         Securities Fraud and Rule 10b-5


               Professor Robert Prentice,
              Ed & Molly Smith Centennial
                  University of Texas
The Future of Corporate Disclosure: The Internet,
        Securities Fraud and Rule 10b-5
I.   Introduction
       •      Securities markets well-suited to Internet technology + SEC
              receptivity = need to revisit disclosure practices
       •      Present disclosure concerns for businesses electronically
              - Formal: Web pages
              - Informal: Bulletin Boards, Newsgroups, E-mail
       •      Discusses key questions and possible solutions to avoiding liability
              related to disclosure practices and 10b-5 issues

           ***No specific case case law (2000), few new rules are needed to protect
           public
The Future of Corporate Disclosure: The Internet,
        Securities Fraud and Rule 10b-5
II. Corporate Web Sites
     •  Is a company liable if it fails to update web site material?
      SEC clearly expects e-documents to be prepared, update and delivered
      consistent with paper (Virgin Airways Example)



       Duty to Update: What did they know and when did they know it?    e.g., Re-
       stating income


      Solutions: Active Home Page Management (Date each document and web
      site alteration). Frequent, periodic review of all company communications.
      Post disclaimers.
The Future of Corporate Disclosure: The Internet,
        Securities Fraud and Rule 10b-5
II. Corporate Web Sites
     •  Is a company liable for overly optimistic video, audio or other information on 
     its site that turn out to be overly optimistic?
    Quite Possibly: Extrapolate Apple Computer” example to web presence
    ($100M)

     Proposed solutions: 1) Inform employees of Rule 10b-5 and its potential
     impact (caution not to overstate products); 2) Establish a Disclosure
     Compliance Committee that:

         -  Identifies important info as it develops
         - Provides mechanism for disclosures
         - Coordinates Company-wide policy
         - Prohibits the abuse of confidential information
The Future of Corporate Disclosure: The Internet,
        Securities Fraud and Rule 10b-5
II. Corporate Web Sites (cont’d)

    •  Is a company liable for misleading statements made by executives, especially 
    where disclaimers that bespeak caution are included in the original and not on 
                            bespeak
    the home page?


      Generally no, if statements bespeaks caution
The Future of Corporate Disclosure: The Internet,
        Securities Fraud and Rule 10b-5
II. Corporate Web Sites (cont’d)
     •  Is a company liable if a hacker breaks into its site and alters F/S in a way that 
     could mislead investors

      Likely. Akin to Tylenol tampering settlement. Due Diligence in protecting
      its site against forseeable risk will be necessary. Site could be manipulated
      to move markets for transgressor.
The Future of Corporate Disclosure: The Internet,
        Securities Fraud and Rule 10b-5
II. Corporate Web Sites (cont’d)
     •  If a company’s web site includes a link to an anlaysts reports, is the company 
     liable if the analyst’s report is inaccurate? 
      Reasonable expectation based on current case law. Elkind v. Liggett &
      Myers, Inc. where court ruled company may be held liable for analysts
      false statements if company “entangled” itself with issuance of the
      analysts report. Making hyperlinks to analysts reports presents same
      entanglement scenario.




      Solutions: 1) Provide no links; 2) Link to every analyst following the
      company; 3) Review analyst’s reports for inaccuracies; 4) Include a
      disclaimer
The Future of Corporate Disclosure: The Internet,
        Securities Fraud and Rule 10b-5
II. Corporate Web Sites (cont’d)
     •  Should companies hire auditors to monitor all such web sites, 
     notwithstanding the AICPA’s current position that its auditors need not even 
     read such on-line information?


      A major challenge of presenting material is its reliability, fairness,
      disclosure and level of monitoring to ensure accuracy and trust-
      worthiness.
      Solutions: Have 3rd party audit site, similar to F/S. Larger national
      firms would be hired to send a signal the company is reliable. SEC has
      predicted this market will evolve.
The Future of Corporate Disclosure: The Internet,
        Securities Fraud and Rule 10b-5
III. Bulletin Boards & Chat Rooms
      •  What are a corporation’s options and obligations if it learns of a misleading 
       posting on a BBS or newsgroup that has the potential to move the market in a 
       company’s stock?
        Reacting to a rumor can sometimes bring it new life. Management must make
        well-reasoned decisions regarding the nature of the rumor, its staying power
        and the cost effectiveness of fighting it {McDonald’s, spent $6 million to win an
        uncollectible $68 K judgement. Beneficial rumors addressed similarly.

       •  How does participation by employees in bulletin board/chat room discussions 
       impact the firm’s potential 10b-5 liability?

        Remember: Those participating in these forums tend to fail the “dead tree”
        test. Creates need for strong policy, tightly-enforced. Make employees aware
        of risks, including their own criminal and civil liability if the share company
        info, in a BBS or chatroom.
The Future of Corporate Disclosure: The Internet,
        Securities Fraud and Rule 10b-5
IV. E-mail
     •  Can internal company e-mail create 10b-5 liabililty?
       Once again, some risks are foreseeable and company should prepare for
       possibility that confidential, internal e-mails could be forwarded to other who
       would misinterpret the facts of their right to that information….and sue.
       Solution: Establish policies and tighten e-mail security to ensure internal e-
       mails are accurate and minimize forwarding internal e-mails to outside
       parties.

       •  What are the insider trading liability ramifications of employee e-mail 
       communications?

        Enforcement of a company policy against insider training. Note: security
        breach of adding “invisible” bytes to an e-mail. 
The Future of Corporate Disclosure: The Internet,
        Securities Fraud and Rule 10b-5
IV. E-mail
    •  Can a company be liable for selective disclosure via e-mail?
     Selective Disclosure to large investors or analysts creates temptation to divulge
     information not available to others. E-mail and Internet create additional
     opportunities for selective disclosure to occur.
     Solution:
              - Limit number of spokespeople;
              - All inquiries should be directed to the spokesperson;
              - Keep responses factual and truthful
The Future of Corporate Disclosure: The Internet,
        Securities Fraud and Rule 10b-5
V.   SEC
     •  Walks the walk: 
         - Web site, On-line interactivity
         -  Liberalized prospectus rules to allow “hyperprospectus” 
         -  Allows Internet IPOs, DPOs, Direct Placements, Road Shows
The Future of Corporate Disclosure: The Internet,
        Securities Fraud and Rule 10b-5
V.   SEC (cont’d)
     •  E-prospectus must meet delivery considerations of 1933 Act, including 
     investor notice of delivery,  access = to paper documents and issuer evidence of 
     delivery.
     •  Informal surveillance, pursuit of transgressors, considering Commodity Futures 
     Trading Commission’s practice of posting “Most Wanted” posters.
     •  SEC:  http://www.sec.gov/divisions/enforce/internetenforce.htm
                                    Have You Seen This Man?


                                        On July 11, 2000, the Division of Enforcement for the Commodity 


  
                                        Futures Trading Commission (CFTC) filed an injunctive action in the
                                        U.S. District Court for the Northern District of Indiana, Fort Wayne 
                                        Division, against Phillip Ferguson d/b/a Ferguson Financial, B&F
                                        Trading ("B&F") and First Investor’s Group Inc. ("FIG"), 
Name: Phillip L. Ferguson               charging him with fraud and registration violations of the Commodity
Last Seen: Marion or Summitville,       Exchange Act and the CFTC’s regulations. The CFTC complaint 
Indiana in June of 2000
                                        charges that Ferguson operated at least two consecutive commodity 
DOB: 02/07/50
Height: 6' 0"                           pools and deposited over $3.8 million into these pools while failing to
Weight: Approximately 200 lbs.          register with the CFTC as a commodity pool operator. It alleges that 
                                        Ferguson also issued false "Trade Logs" to at least one FIG pool 
                                        investor that showed fictitious buys and sells of commodity futures 
                                        contracts and a false account balance of over $129 million as of March
                                        2000. 
                                        On July 20, 2000, the Honorable Judge William C. Lee, United States
                                        District Judge for the Northern District of Indiana, Fort Wayne 
                                        Division, issued a preliminary injunction against Ferguson which, 
                                        among other things, prohibited the transfer or dissipation of any assets
                                        funds or other property controlled by Ferguson. The Court also 
                                        appointed R. David Boyer as a receiver to assist in locating and 
                                        dispensing Ferguson’s assets to investors. Boyer can be contacted at 
                                        (219) 422-7422.
                                        If you have seen Phillip L. Ferguson, please contact the CFTC at 312-
                                        353-7956 or via e-mail.
The Future of Corporate Disclosure: The Internet,
        Securities Fraud and Rule 10b-5
VI. Conclusion

     •  Companies have failed to adopt paper-based procedures in the paperless 
     world, which may cause old risks to re-emerge.
     •  Internet case law is in its infancy, opinions abound but no case law is defined.
     •  Better to evaluate risk and implement controls sufficient to support due 
     diligence on risks that can be reasonably forseen: than to leave yourself 
     exposed. 
         Boston University Journal of
      Science and Technology Law (1997)

Legal Aspects of Internet Securities transactions


          Henrique de Azevedo Ferreira Franca
Legal Aspects of Internet Securities Transactions
I.   Introduction
     •  Focus:  Trading securities over the internet
     •  Which law and regulatory oversight applies?
     •  What information must issuer disclose?
     •  Which forum should decide conflicts?
     •  Emerging markets (e.g., Brazil)
 Legal Aspects of Internet Securities Transactions
II. U.S. Federal Securities Laws
    •  Securities Act of 1933
    •  Securities Exchange Act of 1934
    •  Investment Advisers Act of 1940
    •  Investment Company Act of 1940

    The above define security in any manner required so as any transaction that may 
    harm an American investor will be covered. 

     •  Key Aspect of Securities Transactions: Location of offer or execution
 Legal Aspects of Internet Securities Transactions
III. Complying with U.S. Securities Regulations On-line
    •  Landmark Spring Street IPO (2/95), Regulation A ($5M, 12 mos.)
    •  Registration:  State Exemptions may be allowed for Internet offers even if 
    regulation A not allowed (“testing the waters”). 

    •  Distribution & Delivery:  

             - Only the issuer may place announcements about an intended offering
             - Electronic media must meet same standards as paper
             - Assurance must meet notice (timely and adequate) and delivery burdens,
              potential investors must have access equivalent to that achieved by postal
              mail (not burdensome)
 Legal Aspects of Internet Securities Transactions
III. Complying with U.S. Securities Regulations On-line (cont’d)
    • Prospectus and Tombstone Advertisements – after registration filing, a
    prospectus must be filed and provide disclosure similar to paper document.
    Electronic notice of updates should be sent to potential investors.
    “Tombstone” advertisements can be used to provide information.
    • On-line Securities Offerings
      - IPO’s – Internet makes access to unsophisticated investors easier.
    Disclosure guidance based on case law for paper based communications.
       - Internet Trading Systems (secondary offerings) – Bulletin boards used
    to support secondary market (e.g., list bids/offers for company stock via web
    site). SEC issued no action letter.
 Legal Aspects of Internet Securities Transactions
IV. The Securities Framework in Brazil
   - Comissa de Valores Mobilaros (CVM) regulates securities markets
    - Online trading launched in Brazil, although CVM not yet addressed internet 
    securities trading. 
    -  Global disparities in types of systems and regulatory oversight lead to need for 
    common or compatible electronic devices.   Securities agencies need to be free 
    from local political influence.  Systems should also incorporate:

       * Compatibility with legal systems (generally accepted law)
       * Support of many nations
       * Cost effectiveness and affordability
       * Technological flexibility and compatibility (current platforms, future changes)
 Legal Aspects of Internet Securities Transactions
V.   Jurisdiction
     •  American approach 

         -  Extra-territorial reach not addressed by 1933 or 1934 act
         -  “Conduct” and “effect” tests applied by U.S. courts
              *  Federal courts have jurisdiction if fraudulent conduct occurring in
                  U.S. caused harm
              *  American courts claim jurisdiction if fraudulent act elsewhere causes 
                  effects in the U.S. for American investors.  SEC advises offerings     
                  wishing to avoid commission scrutiny “to guard against sales or       
                  provision of services to U.S. persons…” (Awareness issue)
 Legal Aspects of Internet Securities Transactions
V.   Jurisdiction
      • Brazilian approach
       - Jurisdiction claimed over:
             * Persons domiciled in Brazil
             * Transactions occurring in Brazil.
             * Internet securities transactions not addressed

     • Proposals for cyberspace jurisdiction
      - “Cyber-domicile”: users are citizens of their ISP, users choose a forum and law
        to be used in case of conflict.
      - “Admiral” Approach: Admiralty law of flags applied to local of ISP.
      - Lex Fori Approach: Law of the location of the lawsuit
      - Arbitration and Virtual Arbitration: Treaty, UN Model on Commercial
        Arbitration (1985); “Virtual Magistrate” (AAA)
      - Lex Mercatoria: Create a body of Internet law to be signed by different govt’s.
Legal Aspects of Internet Securities Transactions

VI. Conclusion

    •  Internet increase securities demand though increased access
        ….once legal framework has been established
        ….and technological barriers are resolved

				
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