8/13/2019 Notes on Insider Trading

1/2

Mergers and Acquisitions: Inside Trading Notes

On Scienter:

Section 10(b) of the Securities Exchange Act of 1934 forbids "manipulative" or"deceptive" conduct "in connection with the purchase or sale of any security."Rule 10b- 5, promulgated under 10(b), prohibits the making of "any untrue

statement of material fact" in connection with the purchase or sale of securities.

In order to establish a claim under 10(b) and Rule 10b-5, a plaintiff must provethat the defendant i) made misstatements or omissions; ii) of material fact; iii)with scienter; iv) in connection with the purchase or sale of securities; v) uponwhich the plaintiff relied; and vi) that reliance proximately caused the plaintiff'sinjury. The misrepresentations must touch upon the reasons for the investment'sdecline in value. Scienter is defined as "`a mental state embracing intent todeceive, manipulate, or defraud. A violation of Rule 10b-5 "may be found onlywhere there is intentional or willful conduct designed to deceive or defraudinvestors by controlling or artificially affecting the price of securities.

Scienter must be proven by showing the defendant lacked "a genuine belief thatthe information disclosed was accurate and complete in all material respects."Moreover, as we stated in McLean,"[c]ircumstantial evidence may often be theprincipal, if not the only, means of proving bad faith." We have also recognizedthat recklessness on the part of a defendant meets the scienter requirement ofSection 10(b) and Rule 10b-5. Recklessness, in turn, is defined as: an extremedeparture from the standards of ordinary care ... which presents a danger ofmisleading ... that is either known to the defendant or is so obvious that the actormust be aware of it.

Chiarella case

A duty to disclose information arises if there is a relationship of trust andconfidence between parties to the transaction. Chiarella had no such duty. Hewas not a corporate insider in the acquiring corporation and he did not receiveconfidential information from the target company. He also had no fiduciaryrelationship with the shareholders of the target company: he was not their agent;they placed no trust or confidence in him; indeed, they had no prior dealings withhim. A duty to disclose under Section 10(b) does not arise from the merepossession of nonpublic market information.

Insider Trading in Advance of Acquisitions

. Section 14(e) of the Securities Exchange Act, enacted in 1968 , makes itunlawful for any person "to engage in any fraudulent, deceptive, ormanipulative acts or practices" in connection with a tender offer. Oneviolates Section 14(e) of the Securities Exchange Act, enacted in1968, if he trades on the basis of material nonpublic informationconcerning a pending tender offer that he knows or has reason to know

8/13/2019 Notes on Insider Trading

2/2

Mergers and Acquisitions: Inside Trading Notes

has been acquired "directly or indirectly" from an insider of the offeror orissuer, or someone working on their behalf. Rule 14e-3(a) is a disclosureprovision.

Kern County Land Co. v. Occidental Corp. 36 L. Ed. 2d 503

Insider Trading in Advance of Acquisitions

A purchase and sale of shares will not be considered a sale under Section:

16(b) of the Securities Exchange Act if there was no indication that there was anabuse of insider information.

. Previously, insiders directors, officers, and large shareholders ofcorporations, could freely exploit their positions of trust by usingconfidential corporate information to their advantage in personal market

endeavors.

To prevent such abuse, section 16(b) provides that any profit realized by aninsider from any purchase and sale, or sale and purchase, of any equity securityof his corporation, within a six-month period, must inure to the benefit of thecorpor Section 16(b) of the Securities Exchange Act of 1934, 15 U.S.C. 78p(b),"provides that officers, directors, and holders of more than 10% of the listed stockof any company shall be liable to the company for any profits realized from anypurchase and sale or sale and purchase of such stock occurring within a periodof six months."

In enacting Section 16(b), Congress recognized that insiders could have accessto information about their corporations not available to the trading publicgenerally. The statute states that its purpose is to prevent "the unfair use ofinformation which may have been obtained by such beneficial owner ... byreason of his relationship to the issuer."

It is apparent that the pricing of the transaction was structured in a manner toaccommodate a Section 16(b) liability. The Section 16(b) liability was, in fact,discharged by an appropriate cash payment to Ferro at the close of thetransaction. However, to be culpable under Section 16(b), there must have beenan attempt to avoid payment of the short swing profits imposed thereby.

Moreover, the Supreme Court has determined that a Section 16(b) violation doesnot necessarily attach where the parties have intentionally structured theirtransaction to accommodate the liability imposed by the statute:

Liability cannot be imposed simply because the investor structured histransaction with the intent of avoiding liability under 16(b). The question is,rather, whether the method used to "avoid" liability is one permitted by thestatute.