Taj Mahal Historical Information by onj11786

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									Securities Regulation

      Materiality
What matters to investors?


                      (last updated 12 Jan 11)
Securities Fraud Action
• Parties
   – Plaintiff (purchasers or sellers)
   – Defendant (primary violator /
       including company)

• Elements
   –   Material
   –   Misrepresentation or omission
   –   Scienter
   –   Reliance
   –   Causation
   –   Damages

• Required nexus
   – Jurisdictional nexus (federal court)
   – Transactional nexus (“in
     connection with purchase or sale
     of securities”)
                       Materiality “test”
TSC Industries v. Northway (US 1976):

  A fact is material if "there is a
  substantial likelihood a reasonable
  investor would consider it important"
  in deciding how to vote [whether to
  buy or sell stock.]

  Put another way, there must be a
  substantial likelihood that the
  disclosure of the omitted fact would
  have been viewed by the reasonable
  investor as having significantly
  altered the "total mix" of information
  made available.
Materiality contexts


Forward-looking information
      Historical facts
         Opinions
         Total mix
Forward-looking information

Basic Inc. v. Levinson (US 1987):

• What kind of lawsuit?
• What did plaintiffs allege?
• What were company’s arguments?
    – Overwhelm investors
    – Need secrecy
    – Knowability
• What does 6th Circuit say?
• What does Supreme Court hold?
Forward-looking information

  Basic Inc. v. Levinson (US 1987):

     ... with respect to contingent or
     speculative information or
     events .... materiality "will
     depend at any given time upon
     a balancing of both the
     indicated probability that the
     event will occur and the
     anticipated magnitude of the
     event in light of the totality of
     the company activity"
                                         Justice Harry Blackmun
                      Hypothetical #1

The CEOs of Six Feet and Dearly Departed
  (two publicly-traded mortuary companies)
  have discussed a merger. Price? Ratio?
  Survivor? Antitrust scrutiny?

A reporter from Eulogy Magazine interviews
   David and asks, “Does Six Feet have any
   acquisitions in the pipeline?”

David turns to you, his lawyer. What do you
  whisper to him?
Basic Inc. v. Levinson (US 1987):

    ... a factfinder will need to look to
   indicia of interest in the transaction at
   the highest corporate levels. Without
   attempting to catalog all such
   possible factors, we not by way of
   example that board resolutions,
   instructions to investment bankers,
   and actual negotiations between
   principals or their intermediaries may
   serve as indicia of interest.

fn 17. To be actionable, of course, a
   statement must also be misleading.
   Silence, absent a duty to disclose, is
   not misleading under Rule 10b-5.            Justice Harry Blackmun
   "No comment" statements are
   generally the functional equivalent of
   silence.
                         Hypothetical #2

The Six Feet and Dearly Departed merger
  plans continue apace, but still no final
  deal on price and structure.

Six Feet is about to file its annual report with
   the SEC.

CEO David turns to you again. Must Six Feet
  mention the possibility of a merger?
Regulation S-K, Item 303
  Full Fiscal Years. ...

   (a)(1) Identify any known trends or any
  known ... events ... that will result in or
  that are reasonably likely to result in the
  registrant's liquidity increasing or
  decreasing in any material way.

                    ***

Rule 12b-20

  In addition to the information expressly
  required to be included in a statement or
  report, there shall be added such further
  material information, if any, as may be
  necessary to make the requirement
  statements, in the light of the
  circumstances under which they are
  made not misleading.
Materiality contexts


Forward-looking information
      Historical facts
         Opinions
         Total mix
    Ganino v. Citizens Utilities Co (2d Cir 2000)
• Why are steadily increasing
  earnings so important?

   – Why did Citizens recognize
     1995 fees in 1996? “store
     income”?
   – What happened when
     company comes clean? 4/97
     – rumors, 8/97 10Q
   – Why should investors be
     concerned if fees from
     Hungarian company
     constituted only 1.7% of total
     revenues?

• What did the court decide?
SEC Staff Accounting Bulletin

• “qualitative factors may cause
  misstatements of quantitatively
  small amounts to be material”

• (1) whether misstatement makes a
  change in earnings or other trends
  (2) whether misstatement hides a
  failure to meet analysts’ consensus
  expectations for the enterprise.
        In re Merck & Co. Sec Litig (3d Cir 2005)
•   What was the Medco IPO? And
    why was it scuttled?

•   What was Medco’s “revenue
    recognition” policy?

     – Why recognize revenues that are
       later netted out in computing net
       profits?
     – Why is Merck’s stock price
       affected by sub’s “net zero”
       revenue recognition?

•   What is Merck’s argument that
    Medco’s revenue recognition was
    not material?

•   What does the court conclude
    about Merck’s “delayed,
    piecemeal” disclosure?
                                                       7/5 – 4th S-1 Filing



4/17 – 1st S-1 filing
                                6/21 – WSJ story



                                           7/9 – end of class period




                        An efficient market?
Materiality contexts


Forward-looking information
      Historical facts
         Opinions
         Total mix
        Va Bankshares v. Sandberg (US 1991)

Proxy statement:

  The Plan of Merger has been
  approved by the Board of Directors
  because it provides an opportunity
  for the Bank’s public shareholders
  to achieve high value for their
  shares.

  The price to be paid is about 30%
  higher than the [last trade price
  before announcement of the
  proposal]. The $42 per share to be
  paid public holders represents a
  premium of approximately 26% over
  book value.
         Va Bankshares v. Sandberg (US 1991)

Supreme Court (actionability of statements
  of opinion)

   … Shareholders know that directors
   usually have knowledge and expertness
   far exceeding the normal investor’s
   resources …

   … statements of belief are factual in two
   senses: directors hold the belief stated …
   statement about belief expressed.

   … disbelief, standing alone, is insufficient   Justice David Souter
   to satisfy element of fact
Materiality contexts


Forward-looking information
      Historical facts
         Opinions
         Total mix
        Longman v. Food Lion, Inc (4th Cir 1999)


8/90 – UFCW labor union alleges
   widespread labor violations / FL denies
   employee mistreatment

11/91 – UFCW brings DOL complaint and
   issues press release / company says has
   clear policy against “off the clock”

11/92 – PrimeTimeLive trashes Food Lion’s
   labor practices and sanitation
    – Employees forced to work off the clock /
      big $$$ back pay liability
    – Meat pulled out of dumpster and bleached
      / Ees re-date packages
    – Stock falls 11%
       Longman v. Food Lion, Inc (4th Cir 1999)


Fourth Circuit:

… nature of the off-the-clock claims and
  the claims’ risk to earnings were in
  fact well known to the market before
  the PTL broadcast [no price drop
  after DOL settlement]

… statements [about cleanliness] are a
  kind of puffery … most of broadcast      Sec Reg Record?
  was inadmissible hearsay … isolated
  instances of workplace errors
              Would you invest in this man?
Management Discussion & Analysis:
 “The partnership [to build an Atlantic City
 mega-casino] believes that funds generated
 from the operation of the Taj Mahal will be
 sufficient to cover all of its debt service ...

Elsewhere in the prospectus:
 “… no history of earnings … its operations
 will be subject to all of the risk inherent in
 the establishment of a new business
 enterprise”
 “… [timing of payments] could adversely
 affect its ability to pay interest"
 “… no assurance can be given that Taj             The “Donald”
 Mahal will generate cash flow sufficient to
 pay debt service"
           Materiality in context
Context                Test
(1) Historical facts   TSC v. Northway
                       (“reasonable investor”)
(2) Speculative        Basic v. Levinson
                       (“prob + magnitude”
(3) Opinion            Va Bankshares
                       (“reasons + subject”)
(4) Contextual         “Truth on market” /
                            “bespeaks caution”
           Materiality in context
Context                Test
(1) Historical facts   TSC v. Northway
                       (“reasonable investor”)
(2) Speculative        Basic v. Levinson
                       (“prob + magnitude”)
(3) Opinion            Va Bankshares
                       (“reasons + subject”)
(4) Contextual         “Truth on market” /
                            “bespeaks caution”
           Materiality in context
Context                Test
(1) Historical facts   TSC v. Northway
                       (“reasonable investor”)
(2) Speculative        Basic v. Levinson
                       (“prob + magnitude”
(3) Opinion            Va Bankshares
                       (“reasons + subject”)
(4) Contextual         “Truth on market” /
                            “bespeaks caution”
           Materiality in context
Context                Test
(1) Historical facts   TSC v. Northway
                       (“reasonable investor”)
(2) Speculative        Basic v. Levinson
                       (“prob + magnitude”
(3) Opinion            Va Bankshares
                       (“reasons + subject”)
(4) Contextual         “Truth on market” /
                            “bespeaks caution”
Materiality contexts


Forward-looking information
      Historical facts
         Opinions
         Total mix

   Management integrity
                      Philosophy
“Sunlight is said to be the
 best of disinfectants; electric
 light the most efficient
 policeman.”

                Louis Brandeis
        Other People’s Money (1913)
Corporate federalism
         “Thus social standards newly
           defined [by the Securities
           Act of 1933] gradually
           establish themselves as
           new business habits.”

                     Felix Frankfurter
                        ”creator of ’33 Act”
   In Matter Franchard Corp (SEC 1964)

   Investors
                         Glickman

Class A                         Venada Corp.
shares                Class B
                      shares             Glickman --
                                         • withdraws $2.4 MM
                                            from company
    Franchard Corp.                      • pledges stock on
                                            $4.2 MM loans (24%
                                            interest)
                                         • departs after being
                                            caught in more lies
   In Matter Franchard Corp (SEC 1964)

Disclosure of self-dealing
• “Of cardinal importance in
  any business is the quality of
  management”
   – Withdrawals =
     1.5% book value
   – Diversion to Venada =
     Glicksman dominated
   – Pledges of stock =
     personal loans
   – Default terms on loans =
     change of control possible
• Is all self-dealing “material”?
              Beyond SEC line items?
Rule 12b-20 [See also Rule 408]

  In addition to the information
  expressly required to be
  included in a statement or
  report, there shall be added
  such further material
  information, if any, as may be
  necessary to make the
  requirement statements, in the
  light of the circumstances
  under which they are made not
  misleading.
             Corporate federalism

“To generally require information
  … as to whether directors
  have performed their duties in
  accordance with the
  standards of responsibility
  required of them under State
  law would stretch disclosure
  beyond the limitations
  contemplated by the statutory
  scheme …

                     William Cary
               Chair, SEC (1961-1964)
Criminal behavior …
            SEC v. Fehn (9th Cir 1996)

Would you have invested –
   – “blind pool” public offering?
   – Earlier securities law
     violations?
   – Not disclose CEO Wheeler?
   – Manipulate price in
     aftermarket?


Should lawyer be responsible?
   – What is “aiding and abetting”?
   – What if CEO identity not
     required by line-item form?
   – Must incriminate / disclose
     possible illegality?
     Hypothetical


Intersection of securities law
and other regulatory regimes
              Self incrimination
Drug kingpin Pablo Escobar
hires your client Key Airways,
Inc to bring “cargos” into the
United States. The contract It
represents 1.5% of total
revenues.

Must Key Airways, a public
company, disclose this
contract in its upcoming
quarterly report? Including
possible criminality?
                  Self incrimination
“The mere possibility of incrimination is
insufficient to defeat the strong policies
in favor of disclosure.”
              California v. Byers (US 1971)

                   ***

“… the distinction between “mere”
bribes to foreign officials] and bribes
coupled with kickbacks to the directors
… is fundamental to a meaningful
concept of materiality …. And the
preservation of state corporate law.”
         Gaines v. Houghton (9th Cir. 1981)
The end
Oran v. Stafford (3d Cir 2000)
                Oran v. Stafford (3d Cir 2000)
Timeline:                                •   Investors who bought while
• 2/94 – Belgian cardiologist                AHP knew more than public
   notices link to heart valve leaks         sue. What theory?
• 11/95 – AHP knows of 31                     – 3/97 annual report (new
   European cases / FDA panel                    drugs big hit, no mention of
   approves drug                                 European, Mayo data)
• 3/97 – AHP learns from Mayo                 – 4/97 press release
   Clinic of heart-valve abnormalities           (responds to news reports
   in 17 fen-phen users                          that drugs “safe & effective”
• 7/97 – Mayo data disclosed to               – 7/97 press release
   public / AHP says “investigating”             (discusses Mayo data, but
• 9/97 – FDA says survey shows                   no mention knew 3 mos
   1/3 fen-phen users have heart                 ago)
   troubles
    – AHP withdraws drug / stock price   •   Should have disclosed:
      falls 5%                                – Mayo and European data
    – WSJ reports possible lawsuits /
      price drops another 6%
                                              – Misled FDA
                                              – Knew data earlier than said
Oran v. Stafford (3d Cir 2000)
Third Circuit (Materiality of
  omissions):
   – AHP stock price went up after 7/97
     press release on Mayo data
   – European data was not statistically
     significant / “inconclusive”
   – AHP description of FDA approval
     process was factually correct
   – Mayo and European data was
     “purely speculative” until FDA
     notified AHP of link
Oran v. Stafford (3d Cir 2000)
Third Circuit (Failure to satisfy
  SEC rules):
   – Even if obligated to disclose in
     periodic reports (item 303, Reg S-
     K), no private cause of action
   – SEC standard of materiality
     “signficantly beyond” price
     +magnitude test of Basic
   – Violation of SEC line-item rules not
     necessarily violation of 10b-5

								
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