Financial/Securities Regulations + Alternative Dispute Resolution

CHAPTER 17: FINANCIAL AND SECURITIES REGULATIONS

Regulation of Securities

• Regulation of securities began as part of the program to help the United States overcome the Great Depression of the 1930s (stock market crash of 1929).

• Intent: To give potential investors sufficient information so they can make intelligent investment decisions.

What is a security?

• The US Supreme Court has defined a security as “when one person invests money and looks to others to manage the money for profit.”

  3. Is the investment in a common business activity/enterprise

  4. Is the investment based on a reasonable expectation of profits?

  5. Will these profits be earned through the efforts of someone other than the investor?

Can the sale of orange trees be considered a security?

• SEC v. W.J. Howey Co., 66 S. Ct. 1100 (1946):

  • Howey Company offered to sell orange trees, and Howey-in-the-Hills Service provided contracts for care, harvesting, and marketing.

  • Most buyers were nonresidents of Florida with little knowledge or skill.

  • Question: Is the sale of orange trees a security?

Securities Act of 1933

• Disclosure law with respect to the initial sale of securities to the public.

• Illegal to use interstate means to sell securities without disclosing certain financial information to potential investors.

• Information must be true and not misleading. If inaccurate, liability is imposed upon those responsible.

Who is regulated?

4. Issuer: Individual or business offering a security for sale.

5. Underwriter: Anyone who participates in the original distribution of securities (e.g., securities brokerage firms, investment bankers).

6. Controlling Person: One who controls or is controlled by the issuer, such as a major stockholder.

7. Seller: Anyone who contracts with a purchaser or motivates the purchase transaction.

Documents Involved:

• 1) Registration Statement:

  • Detailed disclosure of financial information to the SEC about the issuer and controlling individuals.

  • Waiting Period: Pre-filing period (legal to engage in preliminary negotiations but not the sale of securities). SEC has 20 days to investigate.

  • Post-effective Period: After waiting period, contracts to buy and sell securities are finalized.

• 2) Prospectus:

  • Financial information provided to initial investors during the post-effective period.

  • Purpose: To provide enough facts for an intelligent investment decision

Liability for Violations of the Securities Act of 1933:

• Criminal: Willful violation or fraud in any offer/sale of securities.

• Civil: Buyer sues for a refund of the investment.

• Causes of Liability:

  • Untrue statements or omissions of material facts in the registration statement or prospectus.

• Defenses to Civil Liability:

  • Materiality: False or misleading information not material to the decision.

  • Statute of Limitations: One or three years (one year from discovery or three years after the sale).

  • Due Diligence: Reasonable investigation conducted by an accountant, ensuring the information is accurate.

Securities Exchange Act of 1934

• Regulates transfers of securities after the initial sale.

• Created the SEC (Securities and Exchange Commission).

• Issuers of registered securities must file periodic reports and disclose significant developments that could affect the value of securities.

Section 10(B) and 10B-5:

• Unlawful to use interstate commerce to defraud anyone in connection with the purchase/sale of securities.

Who can be liable under section 10(B)?

• Lorenzo v. SEC, 139 S. Ct. 1094 (2019):

  • Issue: Are those who disseminate false or misleading statements liable under Rule 10B-5?

  • Answer: Yes. Lorenzo sent emails overstating the value of Waste2Energy, knowing the valuation was incorrect, and was held liable.

SEC (Securities and Exchange Commission)

• Created in 1934 to administer federal securities law.

• Consists of 5 commissioners appointed by the president for 5-year terms.

  • Chairman: Nominated by the president.

  • Quasi-judicial and quasi-legislative powers.

Current SEC Commissioners:

• Mark Uyeda (acting Chairman since 2025)

  • Appointed by Biden in 2022, term expires 2028.

  • Served on SEC staff since 2006.

• Hester Peirce (Appointed by Trump in 2018, term expires 2025).

  • Former Senior Counsel on U.S. Senate Committee on Banking, Housing, and Urban Affairs

• Caroline Crenshaw (Sworn in 2020, term expires 2024).

  • Former SEC staff attorney, Captain in U.S. Army Reserve.

• Gary Gensler (Chair, Appointed by Biden in 2021, term expires 2026).

  • Professor at MIT School of Management, former senior advisor for Sarbanes-Oxley Act

Recent SEC Activity:

• Litigation releases and insider transactions.

Insider Transactions

• Who is an insider?:

  • One who owns more than 10% of any security, or is a director or officer of the issuer.

• Why are there laws and penalties against insider trading?

  • Prevent insiders from trading for profit using nonpublic information.

• Short Swing Profits: Any profit made within a 6-month period is presumed illegal.

Tippees:

• A tippee is someone who learns of nonpublic information from an insider.

• Liable if tipper breaches fiduciary duty or if information is misappropriated.

• United States v. O’Hagan (1997): Tippees can be held liable if they convey confidential information that was to be kept private.

Examples of Insider Trading:

1. Starbucks Situation: If a couple shares nonpublic info in a public place, it’s not insider trading unless there’s a duty to keep the information confidential.

2. Janitor Situation: If the janitor overhears confidential info and trades on it, that’s insider trading.

3. Hedge Fund Manager Situation: If the hedge fund manager uses bribed insider info, it’s illegal.

4. Friend’s Boss Situation: If you trade on confidential information passed by an insider, it’s illegal.

Sarbanes-Oxley Act of 2002

• Response to Enron and WorldCom Scandals (2002).

• Applies to all public companies in the U.S. and accounting firms that audit them.

• Created the Public Company Accounting Oversight Board (PCAOB) for oversight of accounting firms.

• Requires CEOs and CFOs to certify accuracy of quarterly and annual financial statements.

Whistleblower Protection:

• Protects employees, lawyers, and accountants who reveal fraud within public companies.

Is the whistleblower protection good? Why or why not?

Here’s a cleaned-up version of your notes, organized for easy copying and pasting into Google Docs:

CHAPTER 5: ALTERNATIVE DISPUTE RESOLUTION

Why Should We Talk About Conflict Resolution?

• Every day, we constantly and consistently deal with conflicts and disputes.

• In the business world, you will frequently deal with business conflicts as well as employee conflicts.

• In the legal world, almost every civil case settles.

• The book says 95% of civil cases settle before trial.

• I would argue that number should be closer to 99% than 95%.

Conflicts and Disputes

• Conflict

  • Exists when there are 2 or more points of view.

  • Not all conflict is bad. It can lead to discussions/compromise.

• Dispute

  • A conflict can turn into a dispute.

  • Arises when one party makes a claim that another party denies.

  • Can become emotional and confrontational.

How Do We Resolve Conflict?

• Some people may ignore it.

• Litigate: Keep arguing until the other side caves.

• Negotiate.

Styles and Methods of Negotiation

• How would you define “negotiation”?

  1. Process used to persuade or coerce someone to do what you want them to do.

• The book discusses two of the most studied methods for negotiations:

  1. Positional Negotiation

  2. Principled Negotiation

A Business Dispute

• M&N is a business that manufactures large (55+ inches) 4K OLED televisions. The principal market for M&N televisions has been buyers for home use. M&N’s reputation is based on assembling a high-quality TV for a relatively low price. M&N’s biggest problem has been maintaining a large enough, qualified sales force while keeping the price for its TVs below the market average.

• William Dalton operates a nationwide chain of discount department stores called Bill’s Discount Centers. One year ago, Bill’s Discount Centers agreed to buy from M&N a minimum of 250 TVs per month for six months. The agreed-upon price of each TV was $1,250.

• The relationship between M&N and Bill’s worked well. In the fifth month of this initial contract, Bill’s agreed to increase its minimum purchase per month to 750 TVs, committing to this monthly purchase for a 12-month period starting after the sixth month of the original contract. The price per TV was to remain at $1,250.

• M&N was delighted with the arrangement because it allowed M&N to concentrate on increasing its production capacity while reducing the costs of maintaining a large active sales force.

• However, Bill’s began receiving complaints from customers about the lack of quality of M&N’s TVs. These complaints were traced to the newer TVs assembled under M&N’s expanded production program. Despite knowing about these issues, Bill’s never informed M&N of its findings.

• Complaints continued to increase. During the fifth month of the 12-month period, Bill’s purchased only 350 TVs from M&N. When M&N sent an invoice for the 750 TVs specified in the contract, Bill’s refused to pay for any TVs over the 350 actually purchased. In the second week of the sixth month, Bill’s sent M&N written notice canceling the remainder of the sales contract due to the declining quality of M&N’s TVs. M&N offered to reduce the price per TV to $1,050, but Bill’s refused to withdraw its termination letter.

• M&N wants to sue Bill’s for $7,062,500, based on the shortfalls of 400 TVs in the fifth month at $1,250/TV plus 750 TVs times seven months at $1,250/TV. Before filing suit, M&N wants to explore the chances for a negotiated settlement in hopes of salvaging a constructive relationship with Bill’s.

Positional Negotiation

• Parties begin in a competitive style by stating their respective expectations/positions.

• The seller starts with a high price, and the buyer begins with a low purchase price.

• The gap between the two opening positions provides room for give and take.

• Negotiation remains focused on price, with each party focusing on their respective price positions.

• Negative of this type of negotiation:

  • Only focuses on certain terms and not the reason for the underlying conflict causing the problem.

  • In this example, the positions are: you owe me 7 million, and I owe you nothing.

  • Nothing is being done to solve the issue of quality of the product.

Principled Negotiation

• Seven elements of principled, interest-based negotiations:

  1. Communication: Clear communication between these parties may assist in becoming joint problem solvers (without this, the parties will keep blaming each other). Bill’s needs to tell M&N why it is dissatisfied with the contract arrangement.

  2. Relationship: How can each party benefit by continuing their relationship? Communications can help salvage the relationship and even make it stronger.

  3. Interests: Have the parties discussed their real interests with each other?

  4. Options: M&N and Bill’s should brainstorm about possible options or solutions to their dispute. This is the essence of good and effective negotiating.

  5. Legitimacy: Is there a plan/solution to correct the issue? M&N saying it will improve quality versus showing how quality is being improved.

  6. Alternatives: What are the alternatives? M&N can file bankruptcy, and Bill’s might be able to find another supplier. The desirable result of any negotiation is to agree on an outcome that is better than both parties' alternatives.

  7. Commitment: Must conclude with the parties making realistic commitments that can be put into practice.

Alternative Dispute Resolution (ADR)

• ADR can occur without litigation—something parties in dispute can agree upon.

• ADR can occur after litigation has started—agreed upon by the parties or court-ordered.

• ADR can be part of a contractual relationship.

What is the importance of ADR?

• Save time, money, and costs—usually much cheaper than litigation.

• Can preserve a relationship (example: family law cases).

Two Most Popular Forms of ADR

1. Arbitration

   • What is arbitration?: Neutral third party (arbitrator) listens to the facts and issues and then makes the decision. Acts as both the judge and jury.

   • How is arbitration a good thing?

     • A quick and inexpensive resolution of disputes.

     • Private proceeding with no formal record and not open to the press (unlike a lawsuit).

     • Can hire an expert in the area/field to be the arbitrator.

     • Flexibility in the proceedings.

   • Negatives of arbitration?

     • Enforcing arbitration award can be costly.

     • Limited discovery.

     • Limited court formalities (rules of evidence).

     • Compromise result is common.

     • Limited appeal rights.

   • Sample Arbitration Clause: "All disputes, claims, or controversies arising from or relating to this contract shall be resolved by binding arbitration by one arbitrator selected by the parties from an American Arbitration Association list of qualified arbitrators. This arbitration contract is made pursuant to a transaction in interstate commerce, and it shall be governed by the Federal Arbitration Act. The parties voluntarily and knowingly waive any right they have to a jury trial. The parties agree and understand the arbitrator shall have all powers provided by the law and this contract. These powers shall include all legal and equitable remedies, including, but not limited to, money damages, declaratory relief, and injunctive relief."

Arbitrators

• Generally chosen by the disputing parties.

• May be required by the contract or statute to arbitrate.

• Can choose someone with expertise in the area of dispute (e.g., an engineer or contractor in a building dispute).

• The number chosen is usually 1 or 3 (avoid an even number to prevent a tie).

• An award is the decision by the arbitrator.

• Authority over certain matters—what arbitrators have authority to decide has been a topic of controversy and litigation.

Rent-A-Center v. Jackson, 130 S.Ct. 2772 (2010)

• Jackson filed a federal lawsuit claiming his employer had discriminated against him because of his race.

• Rent-A-Center filed a motion to dismiss and to compel arbitration pursuant to a signed agreement.

• Jackson claimed the agreement to arbitrate was unconscionable and unenforceable.

• Rent-A-Center claimed issues of unconscionability and unenforceability were matters for the arbitrator to decide and not the courts.

• HOLDING: The arbitration agreement said the arbitrator had exclusive authority to resolve any dispute involving enforceability of the agreement (delegation provision). Jackson only contested the contract as a whole and not the specific delegation provision—thus, the matter should be resolved by the arbitrator.

Avoid Litigation

14 Penn Plaza v. Pyett, 129 S.Ct. 1456 (2009)

• The case shows how courts rigorously enforce arbitration agreements.

• A lawsuit was filed alleging age discrimination.

• Employer moved to have the lawsuit dismissed and asked for arbitration pursuant to the collective bargaining agreement.

• The District Court denied the motion, and the 2nd Circuit affirmed (CBA cannot deny an employee’s opportunity to litigate a federally protected statutory right).

• USSC: This was a collectively bargained agreement in good faith (freely negotiated). An arbitration provision that is clear and unmistakable is valid.

Can One Dispute an Arbitration Award?

• Yes or no?

  • Yes—limited grounds/options.

  • Generally, the arbitration award is final on both issues of fact and law.

  • Limited basis for appeal.

  • Fraud, corruption, partiality, arbitrator bias, misconduct, etc.

  • In some cases, arbitrator exceeded their powers (a narrow concept).

  • Courts may send cases back to arbitration if they believe an award was improperly made