SECURITIES REGULATION FALL 2018
EXERCISES Professor Lucas
Instructions Unlike a timed exam, the following exercises are intended to test your understanding of the course, the advice you would provide a client in a series of situations, and recommendations you would make to enhance the law of securities regulation. The exercises are broken into three primary areas: (1) The Offering Process in Both Public and Exempt Offerings (2) Securities Act and Antifraud Liability (3) The Scope of Securities Law: Which Acts and Actors Should Be Subject to Securities Regulation? Your responses should be succinct, so please note word count limits provided for each question. You must return your responses to me in Microsoft Word form via email (QLucas@KU.edu) by 5:00pm on Friday, May 4, 2018. Points will be deducted from papers submitted after the deadline. Good Luck!
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(1) The Offering Process in Both Public and Private Offerings (Prompt A) Regulation S provides guidance in international transactions, exempting certain transactions from § 5 of the Securities Act. Consider in the following series whether American securities regulations do and should apply extraterritorially to the following transactions under Regulation S? Please provide rationale for your responses and limit your cumulative responses to this prompt to 600 total words. 1. Lovett’s is a food producer selling meat pies out of a facility on Fleet Street in London, England, UK. After a dramatic increase in the firm’s access to raw materials used for its meat pies, Lovett’s makes a public offering to English investors based in London. The firm’s CEO, Nellie Lovett, made a series of material misstatements in connection with the offering documents, defrauding the English investors. 2. Considering the same facts as in Statement 1, Lovett’s in addition to marketing to investors in England, Lovett’s places an advertisement in the Cleveland Plain Dealer, describing the exceptional value of the offering—available only in England. All purchasers of the offering are from England. 3. Considering the same initial facts as in Statement 1, but now also consider that 10 percent of purchasers of Lovett’s securities are American citizens that purchased through their London, England-based brokers. 4. The Salty Iguana is a Kansas-based company. Looking to “Go Big or Go Home” and replace the English meal staple of the fish and chips, the Salty Iguana conducts a public offering in London, England. Due to certain misrepresentations, the offering defrauds hundreds of English investors. Salty Iguana prepared the offering documents in Kansas, but distributed its materials exclusively in England. (Prompt B) Suppose we have two firms, Universal Exports and SPECTRE. Both firms are based and conduct the majority of their commercial activity in the United States and both operate in the private security business. Universal Exports trades on an efficient public market. SPECTRE does not. Please describe restrictions and rules that may limit business activities of Universal Exports or add costs to the firm’s regular course of business as compared to SPECTRE. Should restrictions applied to certain business activities of Universal Exports be the same as those, if any, for SPECTRE? If not, should the SEC relax regulatory requirements for large, wellfollowed companies like Universal Exports? Please provide rationale for your responses and limit your cumulative responses to this prompt to 400 total words.
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(Prompt C) What purposes do the gun-jumping rules serve? Who is the SEC protecting by discouraging disclosure, particularly assuming rational investors exist in efficient capital markets? If you were to propose reforms to the gun jumping rules, what would you advise and to which rules, if any, would you make particular changes? Please provide rationale for your responses and limit your cumulative responses to this prompt to 400 words. (2) Securities Act and Antifraud Liability (Prompt A) Starting in the mid 1960s, sodium azide was used in the manufacture of airbags in motor vehicles and has been in continuous use since that time. In the 1990s, class-action lawyers began filing suits against automobile manufacturers, contending that sodium azide exposure led to fatal medical conditions in some cases to persons who had been contacted by deploying airbags. In 2012, National Electric Vehicle America (NEVA), a publicly traded corporation new to the United States, acquired Saab Automobile, an automobile company that was a defendant at the time in three sodium azide-related cases, but had sold thousand of vehicles with sodium azide in their airbags. NEVA’s CEO praised the acquisition and when asked about the sodium aziderelated suits, stated the following:
In July 2015, NEVA disclosed that its Saab division had failed to dismiss a claim seeking damages in excess of $20 million in connection with a sodium azide case. NEVA’s stock declined 3.8 percent the next day.
In January 2016, NEVA stated that “concerns about sodium azide are vastly overblown” and that the company’s handling of the suits is “top notch” and should have “no material impact on our bottom line.”
In March 2018, NEVA disclosed a $25million sodium azide verdict issued against its Saab division. NEVA stock plummeted 27 percent the next day, reaching its lowest point since becoming a publicly traded company in the US.
The company believes that a group of plaintiffs plan to file a class action against NEVA for: (1) misleading the public about its liability for sodium azide claims and (2) misleading the public about the benefits of its acquisition of Saab Automobiles. The company has learned that a charitable endowment known as the Kansas Public Employees’ Retirement System (“KPERS”) and four individual plaintiffs plans to act as lead plaintiffs and class representatives in a combined group (“the Group”). The Group will contend that during a class period of 2012 through March 2018, it owned stock in NEVA and was materially harmed by NEVA’s misrepresentations. For counsel, the Group intends to select the Wichita law firm of Westerbeke & McAllister (“W&M”), a personal injury law firm of former law professors with no prior experience in securities cases, but with a scholarly understanding of tort liability cases. The 2
Group intends to pursue a theory contending that investors lost money when NEVA’s stock price dropped following the release of negative news contradicting the prior misrepresentations. The Group also intends to establish class-wide reliance on the misstatements by invoking the “fraudon-the-market” theory. Fearing potential securities litigation, NEVA has retained your services as counsel. The company has asked you to evaluate the statutory (and promulgated rule) basis for the Group’s claims, including required elements and the likelihood of success for plaintiffs on the merits. NEVA also has asked you to consider whether there are any procedural challenges to lead plaintiffs or class certification that may allow the company to disqualify the potential lead plaintiff group or its selected counsel. Finally, NEVA—and its business allies—would like you to evaluate potential legal and policy arguments that can avoid application of the fraud-on-the-market theory to this case. In evaluating the fraud-on-the-market arguments, note that NEVA plans to concede that its stock is sold in an efficient, well-developed market. In your discussion, please address the background of the fraud-on-the-market theory, dissenters from the presumption, and provide some assessment as to whether a modern court may be receptive to abandonment of the theory. Please limit your response to 1,400 words. (3) The Scope of Securities Law: Which Acts and Actors Should Be Subject to Securities Regulation?
(Prompt A) You wish to create a smartphone application that facilitates fast-food orders for college students, but you lack cash. You receive a loan from a wealthy friend and agree to repay the loan in installments and to pay interest in addition to providing a share of your future profits from the firm. His profits depend solely on your ability to pay off the loan? Unbeknownst to you in advance, your friend relied on a third-party lender to help finance your loan. Should the loan from your friend to you be treated as a security both as a matter of law and policy? Please limit your response to 300 words. (Prompt B) Bernard Lee, the CEO of Universal Exports, recently increased his compensation package substantially to $15 million in base salary per year together with options potentially worth an additional $50 million. Lee’s compensation package, if options targets are met, could be worth 12 percent of total firm profits. At the same time, the firm’s recent Form 10-K indicates that Universal Exports’ growth has chilled since new leadership joined SPECTRE, its costs are growing due to pension obligations for senior staff, and profits continue to drop. As a shareholder reading this news you wonder what, if any, securities laws mandate disclosures and you wonder what, if any, other steps you may take to correct what you perceive as an abusive pay package? Please discuss, limiting your answer to 400 words. (Prompt C) 3
UBS decides to resell certificates of deposit to investors. UBS pledges to monitor the banks for quality and sell only the best CDs. UBS also pledges to provide a liquid resale market by collecting information that will match buyers and sellers. Is UBS engaged in the sale of securities? If so, why? Please discuss, limiting your answer to 300 words. (Prompt D) Universal Exports seeks to raise $200 million from the capital markets through an offering of 1 million shares of Class III “preferred� stock at $200 per share. Universal Exports refuses to disclose anything about the Class III preferred stock or its plan for the proceeds. As an investor, will you buy the Class III shares? Would you buy at a lower price? How does securities regulation solve the information asymmetry problem at issue here? Please discuss, limiting your answer to 400 words.
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END OF EXERCISES
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