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22 November 2007
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Description
This a corporate law essay that needs revision and correction.It should be handled with a lawyer/or law professor familar with IRAC format and issues spotting.He/ she should ensure that all the required issues were clearly spotted and dealt with using IRAC format
THE QESTION:
ABCO, Inc., was formed in 1922. By 1978 it was a large diversified corporation with over three billion dollars in assets. It had authorized twenty million shares of common stock. Eleven million, five-hundred thousand (11,500,000) of these shares had been issued. ABCO currently held five-hundred thousand (500,000) in its own name which it had repurchased in the market to use for various employee stock option plans. Another one million (1,000,000) shares were owned by ABSCB, a wholly owned subsidiary of ABCO. The remaining ten million shares were widely held by over ten thousand (10,000) shareholders. Its stock was listed on both the New York and American Stock Exchanges.
On January 15, 1979, ABCO announced a decrease in earnings from $25 to $23 per share. This was attributed primarily to losses sustained by its Electronics Division. Its Electronics Division in the past had accounted for approximately ten percent (10%) of ABCO's total sales. After the announcement the price of ABCO stock declined from $53 to $48. John Director, a member of ABCO's Board of Directors, felt that ABCO would recover so he purchased, on January 30, 1979, one-hundred thousand (100,000) shares of stock at $48 per share.
On February 15, 1979, one of the research scientists of the Electronics Division discovered what appeared to be a major breakthrough in microcircuitry. He reported his discovery to Joe Officer, the President of ABCO, and explained that it would take at least two months to verify. If feasible, the breakthrough would turn the Electronics Division around and enable ABCo to capture a large segment of the available market.
On February 20, Officer bough 50,000 shares of ABCo at $48 per share. Doug Investor, a securities analyst, based on his studies of ABCO's financial statements, decided it was a good investment. On March 1 he purchased 400,000 shares at $48. On March 9 he purchased 500,000 shares at $49. On March 16 he purchased 200,000 shares at $49. On March 30 he purchased 200,000 shares at $48. Fred Seller owned 20,000 shares of ABCO. On March 28 he visited Joe Officer to discuss the future of ABCO. Mr. Officer did not tell Mr. Seller of the possible Electronics Division breakthrough, but offered to buy his shares at $50 per share. Seller agreed.
On April 3, 1979, the breakthrough was confirmed. ABCO's Public Relations Department immediately prepared a release which was carried by all major newspapers and the nationwide wire services. It was picked up and broadcast by the major television and radio news networks as well.
ABCO's stock rose to $60 per share by April 5, 1979.
John Director, needing cash, sold 50,000 of his shares on June 15 at $60 per share. He sold the remaining 40,000 on August 3 at $60 per share. Joe Officer sold all 70,000 of his shares on October 3 at $65 per share.
Doug Investor sold 125,000 shares on September 2 at $43, 75,000 on September 19, 500,000 on September 26, and the remaining 600,000 on October 4. These last three sales were at $60 per share.
1. Fred Seller comes to you today. Advise him of his possible cause(s) of action and any recovery.
2. Jeff Right, another director of ABCO, comes to you today. He wants to know if ABCO has any actions against Officer, Director or Investor, and if so, the possible recovery. Advise him.
THE ESSAY:
In the case at hand, the issue is whether or not Fred Seller has and possible causes of action and right to recovery against any member of the ABCO company. According to the facts, Fred Seller owned 20,000 shares of ABCO. On March 28 Fred Seller visited Joe Officer in order to discuss the future of ABCO. During this meeting Joe Officer offered to buy Fred Seller’s shares at $50.00 per share. Fred Seller agreed.
However, during this meeting Joe Officer failed to inform Fred Seller of the potential Electronics Division breakthrough, in which Joe Officer had previously been informed of. Based on this privileged information, Joe Officer acted to buy additional shares in ABCO’s stock, including those once owned by Fred Seller. Although other officers within ABCO also bought more shares, they did not have access to this privileged information.
Shortly after Fred Seller sold his shares to Joe Officer, the Electronics breakthrough was confirmed and ABCO’s stock rose to $60 per share, allowing Joe Officer to sell all 70,000 of his shares at $65.00 per share.
The issue is whether or not Joe Officer’s buying of the stock based on the privileged information he had is in violation of the law for being insider trading. More so, if Joe Officer’s actions are found to be illegal, the second question is whether or not Fred Seller has a right to recovery against Joe Officer for his illegal actions.
Insider trading is, by itself, a perfectly legal course of action. Insider trading is simply the name given to the act of trading a corporation’s stock among such corporate insiders as officers, employees, stockholders or directors. However, in many jurisdictions, such insider trading is illegal when the corporate insider makes the trades based on information or other materials not available to the public and thus only accessible as a result of the insider’s duty to the corporation.
According to the law, regardless of information used, any and all insider trades must be reported directly to the United States Securities and Exchange Commission. As stated by the United States Securities and Exchange Commission, corporate insiders are “a company’s officers, directors and any beneficial owners of more than ten percent of a class of the company’s equity securities.” Any trades of the corporation’s own stock made by people fitting this definition and based on non-public information is considered to be fraudulent.
The reason these actions are considered fraudulent is because “the insider is violating the trust or fiduciary duty that they owe to the shareholders.” In other words, when a corporate insider accepts a contract for employment with a corporation, their contract is actually with the shareholders. According to the law, this contract creates in the employee a fiduciary duty to place the shareholders’ interests before their own interest in any and all matters related to the corporation. Whenever an insider buys or sells corporate stocks based on privileged company information, they are doing so to benefit their own personal interest over that of the shareholders and thus are in violation of their contractual fiduciary duty.
Since insider trading is a violation of a contractual obligation to the shareholders, an insider is liable for any damages caused to the shareholder resulting from their breach of the fiduciary duty. Liability for insider trading is not mitigated by simply passing the privileged information onto somebody else and not actually themselves. For example, a corporate insider who learns of a privileged piece of information and passes this information onto a relative, who then trades on it, the insider will still be liable for an illegal insider trade.
The process of proving an illegal insider trade is a difficult burden. Often time corporate insiders are able to hid behind nominees, offshore companies and other creative proxies. The cause of action is based on the common law tradition of fraud and the Supreme Court view that a corporate director who bought a company’s stock when he knew it was about to jump in price was an act of fraud as he bought the stock while not disclosing the inside information.
According to the common law tradition of civil fraud, fraud is defined as the intentional making of a false representation of material fact with the specific intent to deceive and which is reasonably relied upon by another person to that person’s detriment.
Section 17 of the Securities Act of 1933 originally codified the illegality of insider trading. Section 16(b) of the Securities Exchange Act of 1934 specifically prohibits the short-swing profits made by a corporate director, officer or stockholder owning more than 10% of a firms shares. More so, Section 10(b) of the 1934 Act prohibits fraud related to any securities trading.
The Insider Trading Sanctions Act of 1984 and the Insider Trading and Securities Fraud Enforcement Act of 1988 both create penalties for fraudulent insider trading. Further, the Security and Exchange Commission’s Full Disclosure requirement mandates that any company that intentionally discloses no-public information to an insider, that company must simultaneously disclose that information to the public also. Further, according to the 1966 Supreme Court Case SEC v. Texas Gulf Sulphur Co., “anyone in possession of inside information must either disclose the information or refrain from trading it.”
In summary, an individual is liable for illegal insider trading if they are a corporate officer or own over ten percent of the company’s stocks, gain access to non-public information regarding the company, fail to make this information immediately public, and make a trade or tell someone else to make a trade based on this information. If a person is found liable for illegal insider trading, they are considered to be guilt of fraud. Further, they are in violation of the fiduciary contract owed to the company’s stockholders, and thus can be held liable for any and all damages suffered by the company’s stock holders as a result of the inside trade.
In the case at hand, Joe Officer is an employee of the corporation. As such, he has a fiduciary duty to the corporation’s shareholders. According to the contractual fiduciary duty, Joe Officer cannot do anything that will place his own interest over the interest of the corporation’s shareholders. More so, besides being a corporate officer, Joe Officer also owns more than ten percent of the corporation’s total stock, thus ensuring that Joe Officer will be considered a corporate insider under any legal analysis.
Second, Joe Officer received privileged, non-public insider information pertaining to a potential development that would assuredly benefit the corporation and increase the worth of its stock. The receiving of this information itself is not illegal so long as Joe Officer took no steps to trade, and thus enrich himself, based on this information. However, since Joe Officer did in fact trade based on this information, he had a duty to immediately report this information to the public. Joe Officer did not do this and thus is guilty of illegal insider trading.
Third, in the case at hand, Fred Seller is a corporate shareholder. Being such, Joe Officer owes a fiduciary duty to Fred Seller. According to this fiduciary duty, Joe Officer must place the best interest of Fred Seller before his own personal interest. When Fred Seller met with Joe Officer, Joe Officer did not disclose the information to Fred Seller, information that would have benefited Fred Seller. More so, Joe Officer offered to buy Fred Seller’s shares knowing that they would soon increase in value. This act was to the detriment of Fred Seller and for the betterment of Joe Officer. Thus, Joe Officer violated his contractual fiduciary duty to Fred Seller.
Because Joe Officer is guilty of illegal insider trading and violated his fiduciary duty to Fred Seller, Joe Officer is liable for any and all damages suffered by Fred Seller as a result of Joe Officer’s illegal actions. In the case at hand, Joe Officer will be liable for the amount of money that Fred Seller lost as a result of selling his stocks prior to the worth going up due to the new Electronics Department development.
Jeff Right, another director of ABCO, is also considering pursuing a claim on behalf of ABCO against either Officer, Director and Investor and is concerned about both whether he has a cause of action and, if so, what is the possible recovery. As previously explained, in order to bring a cause of action against either Officer, Director, or Investor or combination thereof, the first step is to demonstrate that one has committed illegal insider trading.
Again, as has been previously argued in full, the only individual who has engaged in illegal insider trading is Joe Officer. This is because only Joe Officer acted on insider information and only Joe Officer has a fiduciary duty to ABCO. In other words, even though all three individuals were involved in buying and selling ABCO stock, only Joe Officer did so based on insider information that he received. Further more, only Joe Officer has a contractual duty to both the company and the shareholders to work only for their best interest. Thus, if Jeff Right is to bring as a director of ABCO on behalf of ABCO, his only claim would be against Joe Officer for damages that resulted from Joe Officer’s illegal insider trading.
The second step in analyzing Jeff Right’s claim against Joe Officer is to see if Joe Officer can be held liable for damages for the damages suffered by ABCO. As was previously discussed in the scenario involving Seller, it was determined that Jeff Right could be held liable to Seller for the damages that Seller suffered as a result of Joe Officer’s illegal actions. It was stated that in order to hold an individual liable for damages, it must be shown that but for Joe Officer’s illegal actions, the individual making the claim would not have suffered damages.
In the case involving Seller, this issue was relatively straight forward. First, Joe Officer owed Seller a fiduciary, or contractual, duty to put Seller’s interest first. By using insider information to gain the stocks held by Seller, Joe Officer broke this duty. Further, Joe Officer, as an officer of the company, has a duty to publicly announce all insider information gained. Since Joe Officer failed to do this and instead acted on the gained information, he committed an act of illegal insider information. It is this necessary combination of duty owed, illegal action taken and damages caused that need to be established if one is to bring a claim against Joe Officer.
In Jeff Right’s situation, the main issue is whether or not ABCO, as a corporation, can claim damages against Joe Officer. To determine the answer to this issue, one has to ask whether or not ABCO suffered damages as a result of Joe Officer’s actions. As an officer to ABCO, Joe Officer owes a duty to the corporation. As previously stated, Joe Officer’s actions were in breach of this duty. However, typically a business entity cannot claim damages against an individual.
However, a corporation present a special situation as corporations are viewed by the law as being an independent entity as is an individual. Thus, ABCO does have standing to bring a claim against Joe Officer if damages can be shown. In the case at hand, because Seller has a claim of damages against Jeff Officer and Jeff Officer is an employee of ABCO, ABCO can be held vicariously liable for the fraudulent actions of its employees. In other words, ABCO may be held responsible for the monetary damages caused to Seller, and any other effected shareholder, as a result of Joe Officer’s fraudulent actions.
Due to the issue of vicarious liability, ABCO has indeed suffered damages as a result of Joe Officer’s actions. For this reason, they have a right to recover all such damages from Joe Officer, meaning that Jeff Right does have a legitimate claim against Joe Officer.
Bibliography:
Cilliers, Hendrik Tephanus. (1992): Corporate Law. 2nd ed. Durban: Butterworths.
Clare, Robert L., Practicing Law Institute, and London Business School. (1999). The Law, Disclosure and the Securities Market. New York: Practicing Law Institute.
Hazen, T.L. & Federal Judicial Center. (2003). Federal Securities Law (2nd ed.). Washington, DC (Thurgood Marshall Federal Judiciary Bldg., 1 Columbus Circle, N.E. 2002-8003): Federal Judicial Center.
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