The securities and exchange commission sec filed a suit in


Insider Trading

CARDWARE Inc. plans to take over First Class Purses & Accessories (FCPA) in an effort to coordinate elegant CARDWARE professional attire with items from FCPA that will complement CARDWARE's fashion designs. Darla, owner of Darla's Dummies, a mannequin manufacturer whom CARDWARE had used on numerous occasions happened to be delivering mannequins to CARDWARE's principal place of business in Silkadonia. As she was bringing the last of the dummies down the hall to the room where the dummies are dressed, she paused to listen to a conversation coming from one of the open doors of the hallway she was using. Realizing that a profit could be made from FCPA's stock, Darla called her broker and indicated that she wanted to purchase 50 percent of the outstanding stock that was available for FCPA. Darla bought 2,000 shares of stock at $30 a share.

CARDWARE offered $50 a share and ultimately ended up paying $65 per share for FCPA stock. Darla was no dummy, as she made a $70,000 profit on her stock purchase.

The Securities and Exchange Commission (SEC) filed a suit in a federal district court against Darla and others for alleged violations of, among other things, SEC Rule 10b-5. [ SEC v. Falbo 14 F.Supp.2d 508 (S.D.N.Y. 1998)]

Discuss the following, justifying your response using information from your Reading

  1. Under what theory might Darla be liable?
  2. Do the circumstances of this case meet all of the requirements for liability under that theory? Explain.
  3. Examine the SEC Rule 10b-5.
  4. Discuss whether or not Darla was liable under the misappropriation theory.

Class:

The Securities Exchange Act of 1934 granted the Securities and Exchange Commission (SEC) broad authority to make rules aimed to eliminate fraud in the trade of securities. One of the rules that the SEC enacted is Rule 10b-5, which prohibits fraud, misrepresentation, and deceit in the sale and purchase of securities.

Language of SEC Rule 10b-5Rule 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,

1. To employ any device, scheme, or artifice to defraud,

2. 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

3. 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.

Class:

In addition to the SEC's enforcement rights, private citizens also have the right to file lawsuits against companies and individuals for violations of Rule 10b-5. Typically, Rule 10b-5 claims are applied in lawsuits involving:

  • insider trading,
  • market manipulation,
  • fraud in connection with public offerings and takeovers, and
  • fraud in connection with the purchase or sale of securities.

Class:

Consider whether Darla was liable under the misappropriation theory.  The SEC claimed that Darla was liable under the "misappropriation" theory of Rule 10b-5.

As the Court of Appeals for the Second Circuit recently reiterated:

In contrast to the traditional theory of insider trading, under which a corporate insider trades in the securities of his own corporation on the basis of material, non-public information, under the misappropriation theory § 10(b) and Rule 10b-5 are violated whenever a person trades while in knowing possession of material, non-public information that has been gained in violation of a fiduciary duty to its source.

U.S. v. Cusimano, 123 F.3d 83, 87 (2d Cir. 1997), cert. denied, ___ U.S. ___, 118 S.Ct. 1090, 140 L.Ed.2d 146 (1998) (citing U.S. v. Mylett, 97 F.3d 663, 666 (2d Cir.1996), cert. denied, ___ U.S. ___, 117 S.Ct. 2509, 138 L.Ed.2d 1013 (1997)).

Under this theory, a fiduciary's undisclosed, self-serving use of a principal's information to purchase or sell securities, in breach of a duty of loyalty and confidentiality, defrauds the principal of the exclusive use of that information.

U.S. v. O'Hagan, 521 U.S. 642, ___, 117 S.Ct. 2199, 2207, 138 L.Ed.2d 724 (1997).

Solution Preview :

Prepared by a verified Expert
Business Management: The securities and exchange commission sec filed a suit in
Reference No:- TGS01474548

Now Priced at $20 (50% Discount)

Recommended (96%)

Rated (4.8/5)