Deck 21: Assessing Hrm Effectiveness

Question 1

The president's letter in Rockwood Computer Corporation's annual report stated that most of its inventory consisted of its old computer series. The letter suggested that its new series would cost more money for all users. However, the letter did not disclose, although evidence had indicated, that the new system might be less expensive for those who needed greater performance and capacity. Walter Beissinger (who sold his shares based on the information)brought suit under 10(b). Rockwood claims the statements were based on opinions of sales and were not statements of fact. Who should win? [ Beissinger v Rockwood Computer Corp., 529 F. Supp. 770 (E.D. Pa. 1981)]

Answer 1

In this case the president of a company gives his opinion regarding sale of the product in which he says that the inventory of the company consists of old computer series. He also pointed out that the new computer series would be costlier for the customers which actually was not. After getting this information a shareholder of the company sold his shares. He then brought suit against the president on the ground that the president has passed the wrong information.
Here the president has just given his opinion regarding sale and developing of a marketing strategy of the company. He has in no way passed the wrong information to harm the investors. He is not liable for the loss here.

Question 2

William H. Sullivan, Jr., gained control of the New England Patriots Football Club (Patriots)by forming a separate corporation (New Patriots)and merging it with the old one. Plaintiffs are a class of stockholders who voted to accept New Patriots' offer of $15 a share for their common stock in the Patriots' corporation. They now claim that they were induced to accept this offer by a misleading proxy statement drafted under the direction of Mr. Sullivan, who owned a controlling share in the voting stock of the Patriots at the time of the merger. The proxy statement, plaintiffs claim, contained various misrepresentations designed to paint a gloomy picture of the financial position and prospects of the Patriots, so that the shareholders undervalued their stock. They seek to rescind the merger or to receive a higher price per share for the stock they sold. Does the court have the authority to rescind under Section 14? [ Pavlidis v New England Patriots Football Club , 737 F.2d 1227 (1st Cir. 1984)]

Answer 2

The misappropriation theory says that a person does fraud if he knows the confidential information about a security transaction and exploits the information for his own profit. in such case the person violates the section 10 (b). The insider is said to have committed misappropriation if he takes advantage of certain confidential information over the uninformed shareholders.
Here the company has not made any mistake in representing the reason for refusing the merger offer to its shareholder. The decision was taken for the benefit of the company and all shareholders agreed with the decision.

Question 3

The National Bank of Yugoslavia placed $71 million with Drexel Burnham Lambert, Inc., for short-term investment just months before Drexel's bankruptcy. In effect, the bank made a time deposit. Would the bank be able to proceed under a theory of securities laws violations? Would these time deposits be considered securities? [ National Bank of Yugoslavia v Drexel Burnham Lambert, Inc., 768 F.Supp. 1010 (S.D.N.Y 1991)]

Answer 3

Time deposit is a kind of investment in a bank in which the investor cannot withdraw the amount for a certain period of time. In such investment the rate of interest is higher than the saving account. The misappropriation theory says that a person does fraud if he knows the confidential information about a security transaction and exploits the information for his own profit. in such case the person violates the section 10 (b). The insider is said to have committed misappropriation if he takes advantage of certain confidential information over the uninformed shareholders.

Question 4

Escott v BarChris Constr. Corp.
283 F. Supp. 643 (S.D.N.Y. 1968)Bowling for Fraud: Right Up Our Alley
FACTS
BarChris was a bowling alley company established in 1946. The bowling industry grew rapidly when automatic pin resetters went on the market in the mid- 1950s. BarChris began a program of rapid expansion and in 1960 was responsible for the construction of over 3 percent of all bowling alleys in the United States. BarChris used two methods of financing the construction of these alleys, both of which substantially drained the company's cash flow.
In 1959 BarChris sold approximately one-half million shares of common stock. By 1960, its cash flow picture was still troublesome, and it sold debentures. The debenture issue was registered with the SEC, approved, and sold. In spite of the cash boost from the sale, BarChris was still experiencing financial difficulties and declared bankruptcy in October 1962. The debenture holders were not paid their interest; BarChris defaulted.
The purchasers of the BarChris debentures brought suit under Section 11 of the 1933 act. They claimed that the registration statement filed by BarChris contained false information and failed to disclose certain material information. Their suit, which centered on the audited financial statements prepared by a CPA firm, claimed that the statements were inaccurate and full of omissions. The following chart summarizes the problems with the financial statements submitted with the registration statements.
1. 1960 Earnings
(a)Sales
(b)Net Operating Income
(c)Earnings per Share
2. 1960 Balance Sheet
Current Assets
3. Contingent Liabilities as of December 31, 1960, on Alternative Method of Financing
4. Contingent Liabilities as of April 30, 1961
5. Earnings Figures for Quarter Ending
March 31, 1961
(a)Sales
(b)Gross Profit
6. Backlog as of March 31, 1961
7. Failure to Disclose Officers' Loans Outstanding and Unpaid on
8. Failure to Disclose Use of Proceeds in Manner Not Revealed in Prospectus: Approx. $1,160,000
9. Failure to Disclose Customers' Delinquencies in May 1961 and BarChris's Potential Liability with Respect Thereto: Over $1,350,000
10. Failure to Disclose the Fact that BarChris Was Already Engaged and Was About to Be More Heavily Engaged in the Operation of Bowling Alleys
The federal district court reviewed all of the exhibits and statements included in the prospectus and dealt with each defendant individually in issuing its decisions. The defendants consisted of those officers and directors who signed the registration statement, the underwriters of the debenture offering, the auditors (Peat, Marwick, Mitchell Co.5), and BarChris's attorneys and directors.
JUDICIAL OPINION
McLEAN, District Judge
Russo. Russo was, to all intents and purposes, the chief executive officer of BarChris. He was a member of the executive committee. He was familiar with all aspects of the business. He was personally in charge of dealings with the factors. He acted on BarChris's behalf in making the financing agreement with Talcott and he handled the negotiations with Talcott in the spring of 1961. He talked with customers about their delinquencies.
Russo prepared the list of jobs which went into the backlog figure. He knew the status of those jobs.
It was Russo who arranged for the temporary increase in BarChris's cash in banks on December 31, 1960, a transaction which borders on the fraudulent. He was thoroughly aware of BarChris's stringent financial condition in May 1961. He had personally advanced large sums to BarChris of which $175,000 remained unpaid as of May 16.
In short, Russo knew all the relevant facts. He could not have believed that there were no untrue statements or material omissions in the prospectus. Russo has no due diligence defenses.
Vitolo and Pugliese. They were the founders of the business who stuck with it to the end. Vitolo was president and Pugliese was vice president. Despite their titles, their field of responsibility in the administration of BarChris's affairs during the period in question seems to have been less all-embracing than Russo's. Pugliese in particular appears to have limited his activities to supervising the actual construction work. Vitolo and Pugliese are each men of limited education. It is not hard to believe that for them the prospectus was difficult reading, if indeed they read it at all.
But whether it was or not is irrelevant. The liability of a director who signs a registration statement does not depend upon whether or not he read it or, if he did, whether or not he understood what he was reading.
And in any case, Vitolo and Pugliese were not as naive as they claim to be. They were members of BarChris's executive committee. At meetings of that committee BarChris's affairs were discussed at length. They must have known what was going on. Certainly they knew of the inadequacy of cash in 1961. They knew of their own large advances to the company which remained unpaid. They knew that they had agreed not to deposit their checks until the financing proceeds were received. They knew and intended that part of the proceeds were to be used to pay their own loans.
All in all, the position of Vitolo and Pugliese is not significantly different, for present purposes, from Russo's. They could not have believed that the registration statement was wholly true and that no material facts had been omitted. And in any case, there is nothing to show that they made any investigation of anything which they may not have known about or understood. They have not proved their due diligence defenses.
Kircher. Kircher was treasurer of BarChris and its chief financial officer. He is a certified public accountant and an intelligent man. He was thoroughly familiar with BarChris's financial affairs. He knew the terms of BarChris's agreements with Talcott. He knew of the customers' delinquency problems. He participated actively with Russo in May 1961 in the successful effort to hold Talcott off until the financing proceeds came in. He knew how the financing proceeds were to be applied and he saw to it that they were so applied. He arranged the officers' loans and he knew all the facts concerning them.
Moreover, as a member of the executive committee, Kircher was kept informed as to those branches of the business of which he did not have direct charge. He knew about the operation of alleys, present and prospective. In brief, Kircher knew all the relevant facts.
Knowing the facts, Kircher had reason to believe that the expertised portion of the prospectus, i.e., the 1960 figures, was in part incorrect. He could not shut his eyes to the facts and rely on Peat, Marwick for that portion.
As to the rest of the prospectus, knowing the facts, he did not have a reasonable ground to believe it to be true. On the contrary, he must have known that in part it was untrue. Under these circumstances, he was not entitled to sit back and place the blame on the lawyers for not advising him about it. Kircher has not proved his due diligence defenses.
Trilling. Trilling's position is somewhat different from Kircher's. He was BarChris's controller. He signed the registration statement in that capacity, although he was not a director.
Trilling entered BarChris's employ in October 1960. He was Kircher's subordinate. When Kircher asked him for information, he furnished it. On at least one occasion he got it wrong.
Trilling may well have been unaware of several of the inaccuracies in the prospectus. But he must have known of some of them. As a financial officer, he was familiar with BarChris's finances and with its books of account. He knew that part of the cash on deposit on December 31, 1960, had been procured temporarily by Russo for window dressing purposes. He should have known, although perhaps through carelessness he did not know at the time, that BarChris's contingent liability was greater than the prospectus stated. In the light of these facts, I cannot find that Trilling believed the entire prospectus to be true.
But even if he did, he still did not establish his due diligence defenses. He did not prove that as to the parts of the prospectus expertised by Peat, Marwick he had no reasonable ground to believe that it was untrue. He also failed to prove, as to the parts of the prospectus not expertised by Peat, Marwick, that he made a reasonable investigation which afforded him a reasonable ground to believe that it was true. As far as appears, he made no investigation. As a signer, he could not avoid responsibility by leaving it up to others to make it accurate. Trilling did not sustain the burden of proving his due diligence defenses.
Birnbaum. Birnbaum was a young lawyer, admitted to the bar in 1957, who, after brief periods of employment by two different law firms and an equally brief period of practicing in his own firm, was employed by BarChris as house counsel and assistant secretary in October 1960. Unfortunately for him, he became secretary and director of BarChris on April 17, 1961, after the first version of the registration statement had been filed with the Securities and Exchange Commission. He signed the later amendments, thereby becoming responsible for the accuracy of the prospectus in its final form.
It seems probable that Birnbaum did not know of many of the inaccuracies in the prospectus. He must, however, have appreciated some of them. In any case, he made no investigation and relied on the others to get it right. Unlike Trilling, he was entitled to rely upon Peat, Marwick for the 1960 figures, for as far as appears, he had no personal knowledge of the company's books of account or financial transactions. As a lawyer, he should have known his obligations under the statute. He should have known that he was required to make a reasonable investigation of the truth of all the statements in the unexpertised portion of the document which he signed. Having failed to make such an investigation, he did not have reasonable ground to believe that all these statements were true. Birnbaum has not established his due diligence defenses except as to the audited 1960 exhibits.
Auslander. Auslander was an "outside" director, i.e., one who was not an officer of BarChris. He was chairman of the board of Valley Stream National Bank in Valley Stream, Long Island. In February 1961 Vitolo asked him to become a director of BarChris. As an inducement, Vitolo said that when BarChris received the proceeds of a forthcoming issue of securities, it would deposit $1 million in Auslander's bank.
Auslander was elected a director on April 17, 1961. The registration statement in its original form had already been filed, of course without his signature. On May 10, 1961, he signed a signature page for the first amendment to the registration statement which was filed on May 11, 1961. This was a separate sheet without any document attached. Auslander did not know that it was a signature page for a registration statement. He vaguely understood that it was something "for the SEC."
Auslander attended a meeting of BarChris's directors on May 15, 1961. At that meeting he, along with the other directors, signed the signature sheet for the second amendment which constituted the registration statement in its final form. Again, this was only a separate sheet without any document attached. Auslander never saw a copy of the registration statement in its final form. It is true that Auslander became a director on the eve of the financing. He had little opportunity to familiarize himself with the company's affairs.
Section 11 imposes liability in the first instance upon a director, no matter how new he is.
Peat, Marwick. Peat, Marwick's work was in general charge of a member of the firm, Cummings, and more immediately in charge of Peat, Marwick's manager, Logan. Most of the actual work was performed by a senior accountant, Berardi, who had junior assistants, one of whom was Kennedy.
Berardi was then about thirty years old. He was not yet a CPA. He had had no previous experience with the bowling industry. This was his first job as a senior accountant. He could hardly have been given a more difficult assignment.
After obtaining a little background information on BarChris by talking to Logan and reviewing Peat, Marwick's work papers on its 1959 audit, Berardi examined the results of test checks of BarChris's accounting procedures which one of the junior accountants had made, and he prepared an "internal control questionnaire" and an "audit program." Thereafter, for a few days subsequent to December 30, 1960, he inspected BarChris's inventories and examined certain alley construction. Finally, on January 13, 1961, he began his auditing work which he carried on substantially continuously until it was completed on February 24, 1961. Toward the close of the work, Logan reviewed it and made various comments and suggestions to Berardi.
It is unnecessary to recount everything that Berardi did in the course of the audit. We are concerned only with the evidence relating to what Berardi did or did not do with respect to those items found to have been incorrectly reported in the 1960 figures in the prospectus.
Accountants should not be held to a standard higher than that recognized in their profession. I do not do so here. Berardi's review did not come up to that standard. He did not take some of the steps which Peat, Marwick's written program prescribed. He did not spend an adequate amount of time on a task of this magnitude. Most important of all, he was too easily satisfied with glib answers to his inquiries.
This is not to say that he should have made a complete audit. But there were enough danger signals in the materials which he did examine to require some further investigation on his part. Generally accepted accounting standards required such further investigation under these circumstances. It is not always sufficient merely to ask questions.
How much time transpired between the sale of the debentures and BarChris's bankruptcy?

Question 5

Escott v BarChris Constr. Corp.
283 F. Supp. 643 (S.D.N.Y. 1968)Bowling for Fraud: Right Up Our Alley
FACTS
BarChris was a bowling alley company established in 1946. The bowling industry grew rapidly when automatic pin resetters went on the market in the mid- 1950s. BarChris began a program of rapid expansion and in 1960 was responsible for the construction of over 3 percent of all bowling alleys in the United States. BarChris used two methods of financing the construction of these alleys, both of which substantially drained the company's cash flow.
In 1959 BarChris sold approximately one-half million shares of common stock. By 1960, its cash flow picture was still troublesome, and it sold debentures. The debenture issue was registered with the SEC, approved, and sold. In spite of the cash boost from the sale, BarChris was still experiencing financial difficulties and declared bankruptcy in October 1962. The debenture holders were not paid their interest; BarChris defaulted.
The purchasers of the BarChris debentures brought suit under Section 11 of the 1933 act. They claimed that the registration statement filed by BarChris contained false information and failed to disclose certain material information. Their suit, which centered on the audited financial statements prepared by a CPA firm, claimed that the statements were inaccurate and full of omissions. The following chart summarizes the problems with the financial statements submitted with the registration statements.
1. 1960 Earnings
(a)Sales
(b)Net Operating Income
(c)Earnings per Share
2. 1960 Balance Sheet
Current Assets
3. Contingent Liabilities as of December 31, 1960, on Alternative Method of Financing
4. Contingent Liabilities as of April 30, 1961
5. Earnings Figures for Quarter Ending
March 31, 1961
(a)Sales
(b)Gross Profit
6. Backlog as of March 31, 1961
7. Failure to Disclose Officers' Loans Outstanding and Unpaid on
8. Failure to Disclose Use of Proceeds in Manner Not Revealed in Prospectus: Approx. $1,160,000
9. Failure to Disclose Customers' Delinquencies in May 1961 and BarChris's Potential Liability with Respect Thereto: Over $1,350,000
10. Failure to Disclose the Fact that BarChris Was Already Engaged and Was About to Be More Heavily Engaged in the Operation of Bowling Alleys
The federal district court reviewed all of the exhibits and statements included in the prospectus and dealt with each defendant individually in issuing its decisions. The defendants consisted of those officers and directors who signed the registration statement, the underwriters of the debenture offering, the auditors (Peat, Marwick, Mitchell Co.5), and BarChris's attorneys and directors.
JUDICIAL OPINION
McLEAN, District Judge
Russo. Russo was, to all intents and purposes, the chief executive officer of BarChris. He was a member of the executive committee. He was familiar with all aspects of the business. He was personally in charge of dealings with the factors. He acted on BarChris's behalf in making the financing agreement with Talcott and he handled the negotiations with Talcott in the spring of 1961. He talked with customers about their delinquencies.
Russo prepared the list of jobs which went into the backlog figure. He knew the status of those jobs.
It was Russo who arranged for the temporary increase in BarChris's cash in banks on December 31, 1960, a transaction which borders on the fraudulent. He was thoroughly aware of BarChris's stringent financial condition in May 1961. He had personally advanced large sums to BarChris of which $175,000 remained unpaid as of May 16.
In short, Russo knew all the relevant facts. He could not have believed that there were no untrue statements or material omissions in the prospectus. Russo has no due diligence defenses.
Vitolo and Pugliese. They were the founders of the business who stuck with it to the end. Vitolo was president and Pugliese was vice president. Despite their titles, their field of responsibility in the administration of BarChris's affairs during the period in question seems to have been less all-embracing than Russo's. Pugliese in particular appears to have limited his activities to supervising the actual construction work. Vitolo and Pugliese are each men of limited education. It is not hard to believe that for them the prospectus was difficult reading, if indeed they read it at all.
But whether it was or not is irrelevant. The liability of a director who signs a registration statement does not depend upon whether or not he read it or, if he did, whether or not he understood what he was reading.
And in any case, Vitolo and Pugliese were not as naive as they claim to be. They were members of BarChris's executive committee. At meetings of that committee BarChris's affairs were discussed at length. They must have known what was going on. Certainly they knew of the inadequacy of cash in 1961. They knew of their own large advances to the company which remained unpaid. They knew that they had agreed not to deposit their checks until the financing proceeds were received. They knew and intended that part of the proceeds were to be used to pay their own loans.
All in all, the position of Vitolo and Pugliese is not significantly different, for present purposes, from Russo's. They could not have believed that the registration statement was wholly true and that no material facts had been omitted. And in any case, there is nothing to show that they made any investigation of anything which they may not have known about or understood. They have not proved their due diligence defenses.
Kircher. Kircher was treasurer of BarChris and its chief financial officer. He is a certified public accountant and an intelligent man. He was thoroughly familiar with BarChris's financial affairs. He knew the terms of BarChris's agreements with Talcott. He knew of the customers' delinquency problems. He participated actively with Russo in May 1961 in the successful effort to hold Talcott off until the financing proceeds came in. He knew how the financing proceeds were to be applied and he saw to it that they were so applied. He arranged the officers' loans and he knew all the facts concerning them.
Moreover, as a member of the executive committee, Kircher was kept informed as to those branches of the business of which he did not have direct charge. He knew about the operation of alleys, present and prospective. In brief, Kircher knew all the relevant facts.
Knowing the facts, Kircher had reason to believe that the expertised portion of the prospectus, i.e., the 1960 figures, was in part incorrect. He could not shut his eyes to the facts and rely on Peat, Marwick for that portion.
As to the rest of the prospectus, knowing the facts, he did not have a reasonable ground to believe it to be true. On the contrary, he must have known that in part it was untrue. Under these circumstances, he was not entitled to sit back and place the blame on the lawyers for not advising him about it. Kircher has not proved his due diligence defenses.
Trilling. Trilling's position is somewhat different from Kircher's. He was BarChris's controller. He signed the registration statement in that capacity, although he was not a director.
Trilling entered BarChris's employ in October 1960. He was Kircher's subordinate. When Kircher asked him for information, he furnished it. On at least one occasion he got it wrong.
Trilling may well have been unaware of several of the inaccuracies in the prospectus. But he must have known of some of them. As a financial officer, he was familiar with BarChris's finances and with its books of account. He knew that part of the cash on deposit on December 31, 1960, had been procured temporarily by Russo for window dressing purposes. He should have known, although perhaps through carelessness he did not know at the time, that BarChris's contingent liability was greater than the prospectus stated. In the light of these facts, I cannot find that Trilling believed the entire prospectus to be true.
But even if he did, he still did not establish his due diligence defenses. He did not prove that as to the parts of the prospectus expertised by Peat, Marwick he had no reasonable ground to believe that it was untrue. He also failed to prove, as to the parts of the prospectus not expertised by Peat, Marwick, that he made a reasonable investigation which afforded him a reasonable ground to believe that it was true. As far as appears, he made no investigation. As a signer, he could not avoid responsibility by leaving it up to others to make it accurate. Trilling did not sustain the burden of proving his due diligence defenses.
Birnbaum. Birnbaum was a young lawyer, admitted to the bar in 1957, who, after brief periods of employment by two different law firms and an equally brief period of practicing in his own firm, was employed by BarChris as house counsel and assistant secretary in October 1960. Unfortunately for him, he became secretary and director of BarChris on April 17, 1961, after the first version of the registration statement had been filed with the Securities and Exchange Commission. He signed the later amendments, thereby becoming responsible for the accuracy of the prospectus in its final form.
It seems probable that Birnbaum did not know of many of the inaccuracies in the prospectus. He must, however, have appreciated some of them. In any case, he made no investigation and relied on the others to get it right. Unlike Trilling, he was entitled to rely upon Peat, Marwick for the 1960 figures, for as far as appears, he had no personal knowledge of the company's books of account or financial transactions. As a lawyer, he should have known his obligations under the statute. He should have known that he was required to make a reasonable investigation of the truth of all the statements in the unexpertised portion of the document which he signed. Having failed to make such an investigation, he did not have reasonable ground to believe that all these statements were true. Birnbaum has not established his due diligence defenses except as to the audited 1960 exhibits.
Auslander. Auslander was an "outside" director, i.e., one who was not an officer of BarChris. He was chairman of the board of Valley Stream National Bank in Valley Stream, Long Island. In February 1961 Vitolo asked him to become a director of BarChris. As an inducement, Vitolo said that when BarChris received the proceeds of a forthcoming issue of securities, it would deposit $1 million in Auslander's bank.
Auslander was elected a director on April 17, 1961. The registration statement in its original form had already been filed, of course without his signature. On May 10, 1961, he signed a signature page for the first amendment to the registration statement which was filed on May 11, 1961. This was a separate sheet without any document attached. Auslander did not know that it was a signature page for a registration statement. He vaguely understood that it was something "for the SEC."
Auslander attended a meeting of BarChris's directors on May 15, 1961. At that meeting he, along with the other directors, signed the signature sheet for the second amendment which constituted the registration statement in its final form. Again, this was only a separate sheet without any document attached. Auslander never saw a copy of the registration statement in its final form. It is true that Auslander became a director on the eve of the financing. He had little opportunity to familiarize himself with the company's affairs.
Section 11 imposes liability in the first instance upon a director, no matter how new he is.
Peat, Marwick. Peat, Marwick's work was in general charge of a member of the firm, Cummings, and more immediately in charge of Peat, Marwick's manager, Logan. Most of the actual work was performed by a senior accountant, Berardi, who had junior assistants, one of whom was Kennedy.
Berardi was then about thirty years old. He was not yet a CPA. He had had no previous experience with the bowling industry. This was his first job as a senior accountant. He could hardly have been given a more difficult assignment.
After obtaining a little background information on BarChris by talking to Logan and reviewing Peat, Marwick's work papers on its 1959 audit, Berardi examined the results of test checks of BarChris's accounting procedures which one of the junior accountants had made, and he prepared an "internal control questionnaire" and an "audit program." Thereafter, for a few days subsequent to December 30, 1960, he inspected BarChris's inventories and examined certain alley construction. Finally, on January 13, 1961, he began his auditing work which he carried on substantially continuously until it was completed on February 24, 1961. Toward the close of the work, Logan reviewed it and made various comments and suggestions to Berardi.
It is unnecessary to recount everything that Berardi did in the course of the audit. We are concerned only with the evidence relating to what Berardi did or did not do with respect to those items found to have been incorrectly reported in the 1960 figures in the prospectus.
Accountants should not be held to a standard higher than that recognized in their profession. I do not do so here. Berardi's review did not come up to that standard. He did not take some of the steps which Peat, Marwick's written program prescribed. He did not spend an adequate amount of time on a task of this magnitude. Most important of all, he was too easily satisfied with glib answers to his inquiries.
This is not to say that he should have made a complete audit. But there were enough danger signals in the materials which he did examine to require some further investigation on his part. Generally accepted accounting standards required such further investigation under these circumstances. It is not always sufficient merely to ask questions.
Give a summary of the types of items that were materially misstated.

Question 6

Escott v BarChris Constr. Corp.
283 F. Supp. 643 (S.D.N.Y. 1968)Bowling for Fraud: Right Up Our Alley
FACTS
BarChris was a bowling alley company established in 1946. The bowling industry grew rapidly when automatic pin resetters went on the market in the mid- 1950s. BarChris began a program of rapid expansion and in 1960 was responsible for the construction of over 3 percent of all bowling alleys in the United States. BarChris used two methods of financing the construction of these alleys, both of which substantially drained the company's cash flow.
In 1959 BarChris sold approximately one-half million shares of common stock. By 1960, its cash flow picture was still troublesome, and it sold debentures. The debenture issue was registered with the SEC, approved, and sold. In spite of the cash boost from the sale, BarChris was still experiencing financial difficulties and declared bankruptcy in October 1962. The debenture holders were not paid their interest; BarChris defaulted.
The purchasers of the BarChris debentures brought suit under Section 11 of the 1933 act. They claimed that the registration statement filed by BarChris contained false information and failed to disclose certain material information. Their suit, which centered on the audited financial statements prepared by a CPA firm, claimed that the statements were inaccurate and full of omissions. The following chart summarizes the problems with the financial statements submitted with the registration statements.
1. 1960 Earnings
(a)Sales
(b)Net Operating Income
(c)Earnings per Share
2. 1960 Balance Sheet
Current Assets
3. Contingent Liabilities as of December 31, 1960, on Alternative Method of Financing
4. Contingent Liabilities as of April 30, 1961
5. Earnings Figures for Quarter Ending
March 31, 1961
(a)Sales
(b)Gross Profit
6. Backlog as of March 31, 1961
7. Failure to Disclose Officers' Loans Outstanding and Unpaid on
8. Failure to Disclose Use of Proceeds in Manner Not Revealed in Prospectus: Approx. $1,160,000
9. Failure to Disclose Customers' Delinquencies in May 1961 and BarChris's Potential Liability with Respect Thereto: Over $1,350,000
10. Failure to Disclose the Fact that BarChris Was Already Engaged and Was About to Be More Heavily Engaged in the Operation of Bowling Alleys
The federal district court reviewed all of the exhibits and statements included in the prospectus and dealt with each defendant individually in issuing its decisions. The defendants consisted of those officers and directors who signed the registration statement, the underwriters of the debenture offering, the auditors (Peat, Marwick, Mitchell Co.5), and BarChris's attorneys and directors.
JUDICIAL OPINION
McLEAN, District Judge
Russo. Russo was, to all intents and purposes, the chief executive officer of BarChris. He was a member of the executive committee. He was familiar with all aspects of the business. He was personally in charge of dealings with the factors. He acted on BarChris's behalf in making the financing agreement with Talcott and he handled the negotiations with Talcott in the spring of 1961. He talked with customers about their delinquencies.
Russo prepared the list of jobs which went into the backlog figure. He knew the status of those jobs.
It was Russo who arranged for the temporary increase in BarChris's cash in banks on December 31, 1960, a transaction which borders on the fraudulent. He was thoroughly aware of BarChris's stringent financial condition in May 1961. He had personally advanced large sums to BarChris of which $175,000 remained unpaid as of May 16.
In short, Russo knew all the relevant facts. He could not have believed that there were no untrue statements or material omissions in the prospectus. Russo has no due diligence defenses.
Vitolo and Pugliese. They were the founders of the business who stuck with it to the end. Vitolo was president and Pugliese was vice president. Despite their titles, their field of responsibility in the administration of BarChris's affairs during the period in question seems to have been less all-embracing than Russo's. Pugliese in particular appears to have limited his activities to supervising the actual construction work. Vitolo and Pugliese are each men of limited education. It is not hard to believe that for them the prospectus was difficult reading, if indeed they read it at all.
But whether it was or not is irrelevant. The liability of a director who signs a registration statement does not depend upon whether or not he read it or, if he did, whether or not he understood what he was reading.
And in any case, Vitolo and Pugliese were not as naive as they claim to be. They were members of BarChris's executive committee. At meetings of that committee BarChris's affairs were discussed at length. They must have known what was going on. Certainly they knew of the inadequacy of cash in 1961. They knew of their own large advances to the company which remained unpaid. They knew that they had agreed not to deposit their checks until the financing proceeds were received. They knew and intended that part of the proceeds were to be used to pay their own loans.
All in all, the position of Vitolo and Pugliese is not significantly different, for present purposes, from Russo's. They could not have believed that the registration statement was wholly true and that no material facts had been omitted. And in any case, there is nothing to show that they made any investigation of anything which they may not have known about or understood. They have not proved their due diligence defenses.
Kircher. Kircher was treasurer of BarChris and its chief financial officer. He is a certified public accountant and an intelligent man. He was thoroughly familiar with BarChris's financial affairs. He knew the terms of BarChris's agreements with Talcott. He knew of the customers' delinquency problems. He participated actively with Russo in May 1961 in the successful effort to hold Talcott off until the financing proceeds came in. He knew how the financing proceeds were to be applied and he saw to it that they were so applied. He arranged the officers' loans and he knew all the facts concerning them.
Moreover, as a member of the executive committee, Kircher was kept informed as to those branches of the business of which he did not have direct charge. He knew about the operation of alleys, present and prospective. In brief, Kircher knew all the relevant facts.
Knowing the facts, Kircher had reason to believe that the expertised portion of the prospectus, i.e., the 1960 figures, was in part incorrect. He could not shut his eyes to the facts and rely on Peat, Marwick for that portion.
As to the rest of the prospectus, knowing the facts, he did not have a reasonable ground to believe it to be true. On the contrary, he must have known that in part it was untrue. Under these circumstances, he was not entitled to sit back and place the blame on the lawyers for not advising him about it. Kircher has not proved his due diligence defenses.
Trilling. Trilling's position is somewhat different from Kircher's. He was BarChris's controller. He signed the registration statement in that capacity, although he was not a director.
Trilling entered BarChris's employ in October 1960. He was Kircher's subordinate. When Kircher asked him for information, he furnished it. On at least one occasion he got it wrong.
Trilling may well have been unaware of several of the inaccuracies in the prospectus. But he must have known of some of them. As a financial officer, he was familiar with BarChris's finances and with its books of account. He knew that part of the cash on deposit on December 31, 1960, had been procured temporarily by Russo for window dressing purposes. He should have known, although perhaps through carelessness he did not know at the time, that BarChris's contingent liability was greater than the prospectus stated. In the light of these facts, I cannot find that Trilling believed the entire prospectus to be true.
But even if he did, he still did not establish his due diligence defenses. He did not prove that as to the parts of the prospectus expertised by Peat, Marwick he had no reasonable ground to believe that it was untrue. He also failed to prove, as to the parts of the prospectus not expertised by Peat, Marwick, that he made a reasonable investigation which afforded him a reasonable ground to believe that it was true. As far as appears, he made no investigation. As a signer, he could not avoid responsibility by leaving it up to others to make it accurate. Trilling did not sustain the burden of proving his due diligence defenses.
Birnbaum. Birnbaum was a young lawyer, admitted to the bar in 1957, who, after brief periods of employment by two different law firms and an equally brief period of practicing in his own firm, was employed by BarChris as house counsel and assistant secretary in October 1960. Unfortunately for him, he became secretary and director of BarChris on April 17, 1961, after the first version of the registration statement had been filed with the Securities and Exchange Commission. He signed the later amendments, thereby becoming responsible for the accuracy of the prospectus in its final form.
It seems probable that Birnbaum did not know of many of the inaccuracies in the prospectus. He must, however, have appreciated some of them. In any case, he made no investigation and relied on the others to get it right. Unlike Trilling, he was entitled to rely upon Peat, Marwick for the 1960 figures, for as far as appears, he had no personal knowledge of the company's books of account or financial transactions. As a lawyer, he should have known his obligations under the statute. He should have known that he was required to make a reasonable investigation of the truth of all the statements in the unexpertised portion of the document which he signed. Having failed to make such an investigation, he did not have reasonable ground to believe that all these statements were true. Birnbaum has not established his due diligence defenses except as to the audited 1960 exhibits.
Auslander. Auslander was an "outside" director, i.e., one who was not an officer of BarChris. He was chairman of the board of Valley Stream National Bank in Valley Stream, Long Island. In February 1961 Vitolo asked him to become a director of BarChris. As an inducement, Vitolo said that when BarChris received the proceeds of a forthcoming issue of securities, it would deposit $1 million in Auslander's bank.
Auslander was elected a director on April 17, 1961. The registration statement in its original form had already been filed, of course without his signature. On May 10, 1961, he signed a signature page for the first amendment to the registration statement which was filed on May 11, 1961. This was a separate sheet without any document attached. Auslander did not know that it was a signature page for a registration statement. He vaguely understood that it was something "for the SEC."
Auslander attended a meeting of BarChris's directors on May 15, 1961. At that meeting he, along with the other directors, signed the signature sheet for the second amendment which constituted the registration statement in its final form. Again, this was only a separate sheet without any document attached. Auslander never saw a copy of the registration statement in its final form. It is true that Auslander became a director on the eve of the financing. He had little opportunity to familiarize himself with the company's affairs.
Section 11 imposes liability in the first instance upon a director, no matter how new he is.
Peat, Marwick. Peat, Marwick's work was in general charge of a member of the firm, Cummings, and more immediately in charge of Peat, Marwick's manager, Logan. Most of the actual work was performed by a senior accountant, Berardi, who had junior assistants, one of whom was Kennedy.
Berardi was then about thirty years old. He was not yet a CPA. He had had no previous experience with the bowling industry. This was his first job as a senior accountant. He could hardly have been given a more difficult assignment.
After obtaining a little background information on BarChris by talking to Logan and reviewing Peat, Marwick's work papers on its 1959 audit, Berardi examined the results of test checks of BarChris's accounting procedures which one of the junior accountants had made, and he prepared an "internal control questionnaire" and an "audit program." Thereafter, for a few days subsequent to December 30, 1960, he inspected BarChris's inventories and examined certain alley construction. Finally, on January 13, 1961, he began his auditing work which he carried on substantially continuously until it was completed on February 24, 1961. Toward the close of the work, Logan reviewed it and made various comments and suggestions to Berardi.
It is unnecessary to recount everything that Berardi did in the course of the audit. We are concerned only with the evidence relating to what Berardi did or did not do with respect to those items found to have been incorrectly reported in the 1960 figures in the prospectus.
Accountants should not be held to a standard higher than that recognized in their profession. I do not do so here. Berardi's review did not come up to that standard. He did not take some of the steps which Peat, Marwick's written program prescribed. He did not spend an adequate amount of time on a task of this magnitude. Most important of all, he was too easily satisfied with glib answers to his inquiries.
This is not to say that he should have made a complete audit. But there were enough danger signals in the materials which he did examine to require some further investigation on his part. Generally accepted accounting standards required such further investigation under these circumstances. It is not always sufficient merely to ask questions.
Who was sued under Section 11? Who was held liable?

Question 7

United States v O'Hagan
521 U.S. 657 (1997)Pillsbury Dough Boy: The Lawyer / Insider Who Cashed In
FACTS
James Herman O'Hagan (respondent)was a partner in the law firm of Dorsey Whitney in Minneapolis, Minnesota. In July 1988, Grand Metropolitan PLC (Grand Met), a company based in London, retained Dorsey Whitney as local counsel to represent it regarding a potential tender offer for common stock of Pillsbury Company (based in Minneapolis).
Mr. O'Hagan did no work on the Grand Met matter, so on August 18, 1988, he began purchasing call options for Pillsbury stock. Each option gave him the right to purchase 100 shares of Pillsbury stock. By the end of September, Mr. O'Hagan owned more than 2,500 Pillsbury options. Also in September, Mr. O'Hagan purchased 5,000 shares of Pillsbury stock at $39 per share.
Grand Met announced its tender offer in October, and Pillsbury stock rose to $60 per share. Mr. O'Hagan sold his call options and made a profit of $4.3 million.
The SEC indicted Mr. O'Hagan on 57 counts of illegal trading on inside information, including mail fraud, securities fraud, fraudulent trading, and money laundering. The SEC alleged that Mr. O'Hagan used his profits from the Pillsbury options to conceal his previous embezzlement and conversion of his clients' trust funds. Mr. O'Hagan was convicted by a jury on all 57 counts and sentenced to 41 months in prison. A divided Court of Appeals reversed the conviction, and the SEC appealed.
JUDICIAL OPINION
GINSBURG, Justice
We hold, in accord with several other Courts of Appeals, that criminal liability under § 10(b)may be predicated on the misappropriation theory.
Under the "traditional" or "classical theory" of insider trading liability, § 10(b)and Rule 10b-5 are violated when a corporate insider trades in the securities of his corporation on the basis of material, nonpublic information. Trading on such information qualifies as a "deceptive device" under § 10(b), we have affirmed, because "a relationship of trust and confidence [exists] between the shareholders of a corporation and those insiders who have obtained confidential information by reason of their position with that corporation." Chiarella v United States , 445 U.S. 222, 228 (1980). That relationship, we recognized, "gives rise to a duty to disclose [or to abstain from trading] because of the 'necessity of preventing a corporate insider from… tak[ing] unfair advantage of… uninformed… stockholders.'" The classical theory applies not only to officers, directors, and other permanent insiders of a corporation, but also to attorneys, accountants, consultants, and others who temporarily become fiduciaries of a corporation. See Dirks v SEC , 463 U.S. 646, 655, n. 14 (1983).
The "misappropriation theory" holds that a person commits fraud "in connection with" a securities transaction, and thereby violates § 10(b)and Rule 10b-5, when he misappropriates confidential information for securities trading purposes, in breach of a duty owed to the source of the information. 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. In lieu of premising liability on a fiduciary relationship between company insider and purchaser or seller of the company's stock, the misappropriation theory premises liability on a fiduciary-turned-trader's deception of those who entrusted him with access to confidential information.
The two theories are complementary, each addressing efforts to capitalize on nonpublic information through the purchase or sale of securities. The classical theory targets a corporate insider's breach of duty to shareholders with whom the insider transacts; the misappropriation theory outlaws trading on the basis of nonpublic information by a corporate "outsider" in breach of a duty owed not to a trading party, but to the source of the information. The misappropriation theory is thus designed to "protec[t] the integrity of the securities markets against abuses by 'outsiders' to a corporation who have access to confidential information that will affect th[e] corporation's security price when revealed, but who owe no fiduciary or other duty to that corporation's shareholders."
We agree with the Government that misappropriation, as just defined, satisfies § 10(b)'s requirement that chargeable conduct involve a "deceptive device or contrivance" used "in connection with" the purchase or sale of securities. We observe, first, that misappropriators, as the Government describes them, deal in deception. A fiduciary who "[pretends] loyalty to the principal while secretly converting the principal's information for personal gain" "dupes" or defrauds the principal.
Deception through nondisclosure is central to the theory of liability for which the Government seeks recognition. The misappropriation theory comports with § 10(b)'s language. The theory is also well tuned to an animating purpose of the Exchange Act: to insure honest securities markets and thereby promote investor confidence. Although informational disparity is inevitable in the securities markets, investors likely would hesitate to venture their capital in a market where trading based on misappropriated nonpublic information is unchecked by law. An investor's informational disadvantage vis-à-vis a misappropriator with material, nonpublic information stems from contrivance, not luck; it is a disadvantage that cannot be overcome with research or skill.
In sum, considering the inhibiting impact on market participation of trading on misappropriated information, and the congressional purposes underlying § 10(b), it makes scant sense to hold a lawyer like O'Hagan a § 10(b)violator if he works for a law firm representing the target of a tender offer, but not if he works for a law firm representing the bidder.
In sum, the misappropriation theory, as we have examined and explained it in this opinion, is both consistent with the statute and with our precedent. Vital to our decision that criminal liability may be sustained under the misappropriation theory, we emphasize, are two sturdy safeguards Congress has provided regarding scienter. To establish a criminal violation of Rule 10b-5, the Government must prove that a person "willfully" violated the provision. In addition, the statute's "requirement of the presence of culpable intent as a necessary element of the offense does much to destroy any force in the argument that application of the [statute]" in circumstances such as O'Hagan's is unjust.
The Eighth Circuit erred in holding that the misappropriation theory is inconsistent with § 10(b). The Court of Appeals may address on remand O'Hagan's other challenges to his convictions under § 10(b)and Rule 10b-5.
Reversed.
What did Mr. O'Hagan do with information obtained through his employment?

Question 8

United States v O'Hagan
521 U.S. 657 (1997)Pillsbury Dough Boy: The Lawyer / Insider Who Cashed In
FACTS
James Herman O'Hagan (respondent)was a partner in the law firm of Dorsey Whitney in Minneapolis, Minnesota. In July 1988, Grand Metropolitan PLC (Grand Met), a company based in London, retained Dorsey Whitney as local counsel to represent it regarding a potential tender offer for common stock of Pillsbury Company (based in Minneapolis).
Mr. O'Hagan did no work on the Grand Met matter, so on August 18, 1988, he began purchasing call options for Pillsbury stock. Each option gave him the right to purchase 100 shares of Pillsbury stock. By the end of September, Mr. O'Hagan owned more than 2,500 Pillsbury options. Also in September, Mr. O'Hagan purchased 5,000 shares of Pillsbury stock at $39 per share.
Grand Met announced its tender offer in October, and Pillsbury stock rose to $60 per share. Mr. O'Hagan sold his call options and made a profit of $4.3 million.
The SEC indicted Mr. O'Hagan on 57 counts of illegal trading on inside information, including mail fraud, securities fraud, fraudulent trading, and money laundering. The SEC alleged that Mr. O'Hagan used his profits from the Pillsbury options to conceal his previous embezzlement and conversion of his clients' trust funds. Mr. O'Hagan was convicted by a jury on all 57 counts and sentenced to 41 months in prison. A divided Court of Appeals reversed the conviction, and the SEC appealed.
JUDICIAL OPINION
GINSBURG, Justice
We hold, in accord with several other Courts of Appeals, that criminal liability under § 10(b)may be predicated on the misappropriation theory.
Under the "traditional" or "classical theory" of insider trading liability, § 10(b)and Rule 10b-5 are violated when a corporate insider trades in the securities of his corporation on the basis of material, nonpublic information. Trading on such information qualifies as a "deceptive device" under § 10(b), we have affirmed, because "a relationship of trust and confidence [exists] between the shareholders of a corporation and those insiders who have obtained confidential information by reason of their position with that corporation." Chiarella v United States , 445 U.S. 222, 228 (1980). That relationship, we recognized, "gives rise to a duty to disclose [or to abstain from trading] because of the 'necessity of preventing a corporate insider from… tak[ing] unfair advantage of… uninformed… stockholders.'" The classical theory applies not only to officers, directors, and other permanent insiders of a corporation, but also to attorneys, accountants, consultants, and others who temporarily become fiduciaries of a corporation. See Dirks v SEC , 463 U.S. 646, 655, n. 14 (1983).
The "misappropriation theory" holds that a person commits fraud "in connection with" a securities transaction, and thereby violates § 10(b)and Rule 10b-5, when he misappropriates confidential information for securities trading purposes, in breach of a duty owed to the source of the information. 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. In lieu of premising liability on a fiduciary relationship between company insider and purchaser or seller of the company's stock, the misappropriation theory premises liability on a fiduciary-turned-trader's deception of those who entrusted him with access to confidential information.
The two theories are complementary, each addressing efforts to capitalize on nonpublic information through the purchase or sale of securities. The classical theory targets a corporate insider's breach of duty to shareholders with whom the insider transacts; the misappropriation theory outlaws trading on the basis of nonpublic information by a corporate "outsider" in breach of a duty owed not to a trading party, but to the source of the information. The misappropriation theory is thus designed to "protec[t] the integrity of the securities markets against abuses by 'outsiders' to a corporation who have access to confidential information that will affect th[e] corporation's security price when revealed, but who owe no fiduciary or other duty to that corporation's shareholders."
We agree with the Government that misappropriation, as just defined, satisfies § 10(b)'s requirement that chargeable conduct involve a "deceptive device or contrivance" used "in connection with" the purchase or sale of securities. We observe, first, that misappropriators, as the Government describes them, deal in deception. A fiduciary who "[pretends] loyalty to the principal while secretly converting the principal's information for personal gain" "dupes" or defrauds the principal.
Deception through nondisclosure is central to the theory of liability for which the Government seeks recognition. The misappropriation theory comports with § 10(b)'s language. The theory is also well tuned to an animating purpose of the Exchange Act: to insure honest securities markets and thereby promote investor confidence. Although informational disparity is inevitable in the securities markets, investors likely would hesitate to venture their capital in a market where trading based on misappropriated nonpublic information is unchecked by law. An investor's informational disadvantage vis-à-vis a misappropriator with material, nonpublic information stems from contrivance, not luck; it is a disadvantage that cannot be overcome with research or skill.
In sum, considering the inhibiting impact on market participation of trading on misappropriated information, and the congressional purposes underlying § 10(b), it makes scant sense to hold a lawyer like O'Hagan a § 10(b)violator if he works for a law firm representing the target of a tender offer, but not if he works for a law firm representing the bidder.
In sum, the misappropriation theory, as we have examined and explained it in this opinion, is both consistent with the statute and with our precedent. Vital to our decision that criminal liability may be sustained under the misappropriation theory, we emphasize, are two sturdy safeguards Congress has provided regarding scienter. To establish a criminal violation of Rule 10b-5, the Government must prove that a person "willfully" violated the provision. In addition, the statute's "requirement of the presence of culpable intent as a necessary element of the offense does much to destroy any force in the argument that application of the [statute]" in circumstances such as O'Hagan's is unjust.
The Eighth Circuit erred in holding that the misappropriation theory is inconsistent with § 10(b). The Court of Appeals may address on remand O'Hagan's other challenges to his convictions under § 10(b)and Rule 10b-5.
Reversed.
What does the court say the misappropriation theory is?

Question 9

United States v O'Hagan
521 U.S. 657 (1997)Pillsbury Dough Boy: The Lawyer / Insider Who Cashed In
FACTS
James Herman O'Hagan (respondent)was a partner in the law firm of Dorsey Whitney in Minneapolis, Minnesota. In July 1988, Grand Metropolitan PLC (Grand Met), a company based in London, retained Dorsey Whitney as local counsel to represent it regarding a potential tender offer for common stock of Pillsbury Company (based in Minneapolis).
Mr. O'Hagan did no work on the Grand Met matter, so on August 18, 1988, he began purchasing call options for Pillsbury stock. Each option gave him the right to purchase 100 shares of Pillsbury stock. By the end of September, Mr. O'Hagan owned more than 2,500 Pillsbury options. Also in September, Mr. O'Hagan purchased 5,000 shares of Pillsbury stock at $39 per share.
Grand Met announced its tender offer in October, and Pillsbury stock rose to $60 per share. Mr. O'Hagan sold his call options and made a profit of $4.3 million.
The SEC indicted Mr. O'Hagan on 57 counts of illegal trading on inside information, including mail fraud, securities fraud, fraudulent trading, and money laundering. The SEC alleged that Mr. O'Hagan used his profits from the Pillsbury options to conceal his previous embezzlement and conversion of his clients' trust funds. Mr. O'Hagan was convicted by a jury on all 57 counts and sentenced to 41 months in prison. A divided Court of Appeals reversed the conviction, and the SEC appealed.
JUDICIAL OPINION
GINSBURG, Justice
We hold, in accord with several other Courts of Appeals, that criminal liability under § 10(b)may be predicated on the misappropriation theory.
Under the "traditional" or "classical theory" of insider trading liability, § 10(b)and Rule 10b-5 are violated when a corporate insider trades in the securities of his corporation on the basis of material, nonpublic information. Trading on such information qualifies as a "deceptive device" under § 10(b), we have affirmed, because "a relationship of trust and confidence [exists] between the shareholders of a corporation and those insiders who have obtained confidential information by reason of their position with that corporation." Chiarella v United States , 445 U.S. 222, 228 (1980). That relationship, we recognized, "gives rise to a duty to disclose [or to abstain from trading] because of the 'necessity of preventing a corporate insider from… tak[ing] unfair advantage of… uninformed… stockholders.'" The classical theory applies not only to officers, directors, and other permanent insiders of a corporation, but also to attorneys, accountants, consultants, and others who temporarily become fiduciaries of a corporation. See Dirks v SEC , 463 U.S. 646, 655, n. 14 (1983).
The "misappropriation theory" holds that a person commits fraud "in connection with" a securities transaction, and thereby violates § 10(b)and Rule 10b-5, when he misappropriates confidential information for securities trading purposes, in breach of a duty owed to the source of the information. 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. In lieu of premising liability on a fiduciary relationship between company insider and purchaser or seller of the company's stock, the misappropriation theory premises liability on a fiduciary-turned-trader's deception of those who entrusted him with access to confidential information.
The two theories are complementary, each addressing efforts to capitalize on nonpublic information through the purchase or sale of securities. The classical theory targets a corporate insider's breach of duty to shareholders with whom the insider transacts; the misappropriation theory outlaws trading on the basis of nonpublic information by a corporate "outsider" in breach of a duty owed not to a trading party, but to the source of the information. The misappropriation theory is thus designed to "protec[t] the integrity of the securities markets against abuses by 'outsiders' to a corporation who have access to confidential information that will affect th[e] corporation's security price when revealed, but who owe no fiduciary or other duty to that corporation's shareholders."
We agree with the Government that misappropriation, as just defined, satisfies § 10(b)'s requirement that chargeable conduct involve a "deceptive device or contrivance" used "in connection with" the purchase or sale of securities. We observe, first, that misappropriators, as the Government describes them, deal in deception. A fiduciary who "[pretends] loyalty to the principal while secretly converting the principal's information for personal gain" "dupes" or defrauds the principal.
Deception through nondisclosure is central to the theory of liability for which the Government seeks recognition. The misappropriation theory comports with § 10(b)'s language. The theory is also well tuned to an animating purpose of the Exchange Act: to insure honest securities markets and thereby promote investor confidence. Although informational disparity is inevitable in the securities markets, investors likely would hesitate to venture their capital in a market where trading based on misappropriated nonpublic information is unchecked by law. An investor's informational disadvantage vis-à-vis a misappropriator with material, nonpublic information stems from contrivance, not luck; it is a disadvantage that cannot be overcome with research or skill.
In sum, considering the inhibiting impact on market participation of trading on misappropriated information, and the congressional purposes underlying § 10(b), it makes scant sense to hold a lawyer like O'Hagan a § 10(b)violator if he works for a law firm representing the target of a tender offer, but not if he works for a law firm representing the bidder.
In sum, the misappropriation theory, as we have examined and explained it in this opinion, is both consistent with the statute and with our precedent. Vital to our decision that criminal liability may be sustained under the misappropriation theory, we emphasize, are two sturdy safeguards Congress has provided regarding scienter. To establish a criminal violation of Rule 10b-5, the Government must prove that a person "willfully" violated the provision. In addition, the statute's "requirement of the presence of culpable intent as a necessary element of the offense does much to destroy any force in the argument that application of the [statute]" in circumstances such as O'Hagan's is unjust.
The Eighth Circuit erred in holding that the misappropriation theory is inconsistent with § 10(b). The Court of Appeals may address on remand O'Hagan's other challenges to his convictions under § 10(b)and Rule 10b-5.
Reversed.
Could others have done research and obtained the same information?

Question 10

The Farmer's Cooperative of Arkansas (Co-Op)was an agricultural cooperative that had approximately 23,000 members. In order to raise money to support its general business operations, the Co-Op sold promissory notes payable on demand by the holder. The notes were uncollateralized and uninsured and paid a variable rate of interest that was adjusted to make it higher than the rate paid by local financial institutions. The notes were offered to members and nonmembers and were marketed as an "investment program." Advertisements for the notes, which appeared in the Co-Op newsletter, read in part: "YOUR CO-OP has more than $11,000,000 in assets to stand behind your investments. The Investment is not Federal [ sic ] insured but it is… Safe."
Despite the assurance, the Co-Op filed for bankruptcy in 1984. At the time of the bankruptcy filing, over 1,600 people held notes worth a total of $10 million.
After the bankruptcy filing, a class of note holders filed suit against Arthur Young Co., alleging that Young had failed to follow generally accepted accounting principles in its audit, specifically with respect to the valuation of the Co-Op's major asset, a gasohol plant. The note holders claimed that if Young had properly treated the plant in its audited financials, they would not have purchased the notes. The petitioners were awarded $6.1 million in damages by the federal district court. Are the notes securities? [ Reves v Ernst Young, 494 U.S. 56 (1990)]

Question 11

United States v O'Hagan
521 U.S. 657 (1997)Pillsbury Dough Boy: The Lawyer / Insider Who Cashed In
FACTS
James Herman O'Hagan (respondent)was a partner in the law firm of Dorsey Whitney in Minneapolis, Minnesota. In July 1988, Grand Metropolitan PLC (Grand Met), a company based in London, retained Dorsey Whitney as local counsel to represent it regarding a potential tender offer for common stock of Pillsbury Company (based in Minneapolis).
Mr. O'Hagan did no work on the Grand Met matter, so on August 18, 1988, he began purchasing call options for Pillsbury stock. Each option gave him the right to purchase 100 shares of Pillsbury stock. By the end of September, Mr. O'Hagan owned more than 2,500 Pillsbury options. Also in September, Mr. O'Hagan purchased 5,000 shares of Pillsbury stock at $39 per share.
Grand Met announced its tender offer in October, and Pillsbury stock rose to $60 per share. Mr. O'Hagan sold his call options and made a profit of $4.3 million.
The SEC indicted Mr. O'Hagan on 57 counts of illegal trading on inside information, including mail fraud, securities fraud, fraudulent trading, and money laundering. The SEC alleged that Mr. O'Hagan used his profits from the Pillsbury options to conceal his previous embezzlement and conversion of his clients' trust funds. Mr. O'Hagan was convicted by a jury on all 57 counts and sentenced to 41 months in prison. A divided Court of Appeals reversed the conviction, and the SEC appealed.
JUDICIAL OPINION
GINSBURG, Justice
We hold, in accord with several other Courts of Appeals, that criminal liability under § 10(b)may be predicated on the misappropriation theory.
Under the "traditional" or "classical theory" of insider trading liability, § 10(b)and Rule 10b-5 are violated when a corporate insider trades in the securities of his corporation on the basis of material, nonpublic information. Trading on such information qualifies as a "deceptive device" under § 10(b), we have affirmed, because "a relationship of trust and confidence [exists] between the shareholders of a corporation and those insiders who have obtained confidential information by reason of their position with that corporation." Chiarella v United States , 445 U.S. 222, 228 (1980). That relationship, we recognized, "gives rise to a duty to disclose [or to abstain from trading] because of the 'necessity of preventing a corporate insider from… tak[ing] unfair advantage of… uninformed… stockholders.'" The classical theory applies not only to officers, directors, and other permanent insiders of a corporation, but also to attorneys, accountants, consultants, and others who temporarily become fiduciaries of a corporation. See Dirks v SEC , 463 U.S. 646, 655, n. 14 (1983).
The "misappropriation theory" holds that a person commits fraud "in connection with" a securities transaction, and thereby violates § 10(b)and Rule 10b-5, when he misappropriates confidential information for securities trading purposes, in breach of a duty owed to the source of the information. 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. In lieu of premising liability on a fiduciary relationship between company insider and purchaser or seller of the company's stock, the misappropriation theory premises liability on a fiduciary-turned-trader's deception of those who entrusted him with access to confidential information.
The two theories are complementary, each addressing efforts to capitalize on nonpublic information through the purchase or sale of securities. The classical theory targets a corporate insider's breach of duty to shareholders with whom the insider transacts; the misappropriation theory outlaws trading on the basis of nonpublic information by a corporate "outsider" in breach of a duty owed not to a trading party, but to the source of the information. The misappropriation theory is thus designed to "protec[t] the integrity of the securities markets against abuses by 'outsiders' to a corporation who have access to confidential information that will affect th[e] corporation's security price when revealed, but who owe no fiduciary or other duty to that corporation's shareholders."
We agree with the Government that misappropriation, as just defined, satisfies § 10(b)'s requirement that chargeable conduct involve a "deceptive device or contrivance" used "in connection with" the purchase or sale of securities. We observe, first, that misappropriators, as the Government describes them, deal in deception. A fiduciary who "[pretends] loyalty to the principal while secretly converting the principal's information for personal gain" "dupes" or defrauds the principal.
Deception through nondisclosure is central to the theory of liability for which the Government seeks recognition. The misappropriation theory comports with § 10(b)'s language. The theory is also well tuned to an animating purpose of the Exchange Act: to insure honest securities markets and thereby promote investor confidence. Although informational disparity is inevitable in the securities markets, investors likely would hesitate to venture their capital in a market where trading based on misappropriated nonpublic information is unchecked by law. An investor's informational disadvantage vis-à-vis a misappropriator with material, nonpublic information stems from contrivance, not luck; it is a disadvantage that cannot be overcome with research or skill.
In sum, considering the inhibiting impact on market participation of trading on misappropriated information, and the congressional purposes underlying § 10(b), it makes scant sense to hold a lawyer like O'Hagan a § 10(b)violator if he works for a law firm representing the target of a tender offer, but not if he works for a law firm representing the bidder.
In sum, the misappropriation theory, as we have examined and explained it in this opinion, is both consistent with the statute and with our precedent. Vital to our decision that criminal liability may be sustained under the misappropriation theory, we emphasize, are two sturdy safeguards Congress has provided regarding scienter. To establish a criminal violation of Rule 10b-5, the Government must prove that a person "willfully" violated the provision. In addition, the statute's "requirement of the presence of culpable intent as a necessary element of the offense does much to destroy any force in the argument that application of the [statute]" in circumstances such as O'Hagan's is unjust.
The Eighth Circuit erred in holding that the misappropriation theory is inconsistent with § 10(b). The Court of Appeals may address on remand O'Hagan's other challenges to his convictions under § 10(b)and Rule 10b-5.
Reversed.
What advice would you give to those who are employed in law and equity firms that are working on pending deals?

Question 12

In August 1994, Mervyn Cooper, a psychotherapist, was providing marriage counseling to a Lockheed executive. The executive had been assigned to conduct the due diligence (review of the accuracy of the books and records)of Martin Marietta, a company with which Lockheed was going to merge.
At his August 22, 1994, session with Mr. Cooper, the executive revealed to him the pending, but nonpublic, merger. Following his session with the executive, Mr. Cooper contacted a friend, Kenneth Rottenberg, and told him about the pending merger. They agreed that Mr. Rottenberg would open a brokerage account so they could buy Lockheed call options and common stocks and then share in the profits.
When Mr. Rottenberg went to some brokerage offices to set up an account, he was warned by a broker about the risks of call options. Mr. Rottenberg told the broker that Lockheed would announce a major business combination shortly and that he would not lose his money.
Did Mr. Rottenberg and Mr. Cooper violate Section 10(b)? What about the broker? [ SEC v Mervyn Cooper and Kenneth E. Rottenberg, No. 95-8535 (C.D. Cal. 1995)]

Question 13

Goldman Sachs: The Gold (?)Standard of Wall Street
Goldman Sachs was founded in 1869 as an originator and a clearinghouse for commercial paper. Marcus Goldman, a German immigrant, founded the company along with his son-in-law, Samuel Sachs. But the stodgy negotiable instruments market proved insufficient as the firm drifted from its founders' influence and its basic roots in tangible one-on-one business loans to more complex and sophisticated financial instruments.
In 1999, the same year Goldman itself went public, Goldman underwrote 47 companies. The 1990s investors did not know that the standard underwriting practice of requiring that a company show three years of profitability before being taken public was no longer enforced. That profitability standard had been slowly eased back to one year and then to one quarter. In fact, some Internet IPOs that Goldman underwrote had not yet seen any profits and their business plans indicated that profits were not on the immediate horizon.
In addition, Goldman engaged in laddering in the 1990s. Goldman and its best clients arranged for the allocation of a certain portion of an IPO at a preestablished price. However, those clients also had to agree to purchase a certain number of shares later during the IPO rollout at $10-$15 higher. Laddering is a trick, a sort of insider scam by the underwriter and its favored clients. The underwriter locks precommitted buyers into a price above the initial price and the shares of the IPO are guaranteed to rise. Goldman knows the fixed hand, but those in the market who are evaluating the IPO do not know that the increase in price is not due to legitimate demand for the company's shares.
For example, in 2000, Goldman was the underwriter for eToys, whose stock was priced for the IPO at $20. Goldman had laddered the shares and the price climbed to $75 per share by the end of the first day. By March 2001, eToys was in bankruptcy. Then-Goldman Chairman Hank Paulson condemned the practice when the firm received its SEC Wells notice for laddering, but denied any charges of securities fraud. Goldman settled the SEC charges of laddering by agreeing to pay a $40 million fine. 13
In the 2000s, Goldman was a big player in mortgage-backed securities such as collateralized debt obligations (CDOs). Goldman made recommendations to clients to purchase CDOs as it was pushing to have the instruments rated high even as it was positioning itself short on the instruments. Positioning short means that Goldman stood to make money when the value of the CDOs declined. Internal e-mails at Goldman found the investment banker referring to CDO securities as "junk," "s_____," or "crappy." 14 When Goldman executives were asked at a congressional hearing about their internal negative characterizations of securities the firm was touting and selling to its clients, Goldman executive David Viniar responded, "I think that's very unfortunate to have on e-mail." When his response elicited laughter in the hearing room, Mr. Viniar changed his answer to, "It's very unfortunate to have said that in any form." 15
When the real estate market declined rapidly, the value of the CDOs plummeted to junk levels. Goldman received $10 billion from the U.S. government as a bailout. In addition, the government had to bail out AIG, the insurer Goldman had used for its hedges against the CDO market.
Goldman's 2009 annual revenues topped $13 billion, with first-quarter earnings for 2010 of $3.2 billion showing it on track for a repeat. The company has 32,000 employees worldwide and takes no new clients unless they have a minimum of $10 million to invest. The company has several management mantras. One is "long-term greedy," which Goldman executives translate to mean "don't kill the marketplace," 16 and the other is "filthy rich by 40," a motivator for young people.
The SEC filed a civil action against Goldman for its conduct in ABACUS, a CDO deal. According to the complaint, 31-year-old Goldman employee Fabrice Tourre put together a deal of CDOs with the mortgage pool handpicked by John Paulson, a financial wizard who planned to position himself short on the securities Goldman would sell to its clients. The SEC complaint shows that Paulson chose mortgage pools that were dogs, i.e., "crappy." Those mortgages were chosen because these securities "tanking" was important to Goldman and Paulson due to their positions on the mortgage instrument markets.
Goldman's position is that the clients who purchased the instruments were "qualified" or "sophisticated" investors and had a sufficient level of knowledge of markets to understand and process the risk and realize that all investment bankers are positioned in the market according to their theories on risk.
Goldman's activities have been described as "Heads Goldman wins, tails you lose." 17 And "Every game has a sucker, and in this case, the sucker was not so much AIG as it was the U.S. government and the taxpayer." 18 Goldman CEO Lloyd Blankfein defended his firm's conduct in November 2009 in an interview with the London Times by stating that he was just a banker "doing God's work." 19
What are the results when companies create a business model based on loopholes and interpretations of the law?

Question 14

Rollo Norton II, a.k.a. Rick, a financial planner, worked diligently for a number of years to try to keep a San Diego condo project afloat during a real estate downturn. He has confessed to forging signatures, faking loan applications, kiting checks intended for deposit in escrow accounts, and using credit of buyers to borrow money to keep his project going. He and two associates entered guilty pleas and are cooperating with federal authorities in their ongoing investigation of the project.
Fidelity National Financial, which is the largest title insurance company in the United States, was the title insurer for most of the buyers in the project. The project began to unwind in 2006 when several buyer victims filed suit and the architect for the project entered a guilty plea to fraud. However, Fidelity did not disclose the suits, suits that increased from 2006 until October 2009 when the fraud issues emerged. There is no mention in any of the company's 8-K, 10-Q, or 10-K filings about the developments in the project, the litigation, or the guilty pleas.
When Fidelity shareholders filed suit against the company for violations of 10b, company expert witnesses maintained that disclosure when there is uncertainty can harm the company's share price and result in unnecessary losses.
Should there have been disclosure? Of what, how much, and when?

Question 15

Goldman Sachs: The Gold (?)Standard of Wall Street
Goldman Sachs was founded in 1869 as an originator and a clearinghouse for commercial paper. Marcus Goldman, a German immigrant, founded the company along with his son-in-law, Samuel Sachs. But the stodgy negotiable instruments market proved insufficient as the firm drifted from its founders' influence and its basic roots in tangible one-on-one business loans to more complex and sophisticated financial instruments.
In 1999, the same year Goldman itself went public, Goldman underwrote 47 companies. The 1990s investors did not know that the standard underwriting practice of requiring that a company show three years of profitability before being taken public was no longer enforced. That profitability standard had been slowly eased back to one year and then to one quarter. In fact, some Internet IPOs that Goldman underwrote had not yet seen any profits and their business plans indicated that profits were not on the immediate horizon.
In addition, Goldman engaged in laddering in the 1990s. Goldman and its best clients arranged for the allocation of a certain portion of an IPO at a preestablished price. However, those clients also had to agree to purchase a certain number of shares later during the IPO rollout at $10-$15 higher. Laddering is a trick, a sort of insider scam by the underwriter and its favored clients. The underwriter locks precommitted buyers into a price above the initial price and the shares of the IPO are guaranteed to rise. Goldman knows the fixed hand, but those in the market who are evaluating the IPO do not know that the increase in price is not due to legitimate demand for the company's shares.
For example, in 2000, Goldman was the underwriter for eToys, whose stock was priced for the IPO at $20. Goldman had laddered the shares and the price climbed to $75 per share by the end of the first day. By March 2001, eToys was in bankruptcy. Then-Goldman Chairman Hank Paulson condemned the practice when the firm received its SEC Wells notice for laddering, but denied any charges of securities fraud. Goldman settled the SEC charges of laddering by agreeing to pay a $40 million fine. 13
In the 2000s, Goldman was a big player in mortgage-backed securities such as collateralized debt obligations (CDOs). Goldman made recommendations to clients to purchase CDOs as it was pushing to have the instruments rated high even as it was positioning itself short on the instruments. Positioning short means that Goldman stood to make money when the value of the CDOs declined. Internal e-mails at Goldman found the investment banker referring to CDO securities as "junk," "s_____," or "crappy." 14 When Goldman executives were asked at a congressional hearing about their internal negative characterizations of securities the firm was touting and selling to its clients, Goldman executive David Viniar responded, "I think that's very unfortunate to have on e-mail." When his response elicited laughter in the hearing room, Mr. Viniar changed his answer to, "It's very unfortunate to have said that in any form." 15
When the real estate market declined rapidly, the value of the CDOs plummeted to junk levels. Goldman received $10 billion from the U.S. government as a bailout. In addition, the government had to bail out AIG, the insurer Goldman had used for its hedges against the CDO market.
Goldman's 2009 annual revenues topped $13 billion, with first-quarter earnings for 2010 of $3.2 billion showing it on track for a repeat. The company has 32,000 employees worldwide and takes no new clients unless they have a minimum of $10 million to invest. The company has several management mantras. One is "long-term greedy," which Goldman executives translate to mean "don't kill the marketplace," 16 and the other is "filthy rich by 40," a motivator for young people.
The SEC filed a civil action against Goldman for its conduct in ABACUS, a CDO deal. According to the complaint, 31-year-old Goldman employee Fabrice Tourre put together a deal of CDOs with the mortgage pool handpicked by John Paulson, a financial wizard who planned to position himself short on the securities Goldman would sell to its clients. The SEC complaint shows that Paulson chose mortgage pools that were dogs, i.e., "crappy." Those mortgages were chosen because these securities "tanking" was important to Goldman and Paulson due to their positions on the mortgage instrument markets.
Goldman's position is that the clients who purchased the instruments were "qualified" or "sophisticated" investors and had a sufficient level of knowledge of markets to understand and process the risk and realize that all investment bankers are positioned in the market according to their theories on risk.
Goldman's activities have been described as "Heads Goldman wins, tails you lose." 17 And "Every game has a sucker, and in this case, the sucker was not so much AIG as it was the U.S. government and the taxpayer." 18 Goldman CEO Lloyd Blankfein defended his firm's conduct in November 2009 in an interview with the London Times by stating that he was just a banker "doing God's work." 19
Evaluate Goldman's ethics on the role it believed it played with its clients.

Question 16

Steve Hindi is an animal rights activist who owns $5,000 in Pepsi stock. He discovered that Pepsi advertises in bull rings in Spain and Mexico, and he has attended annual shareholder meetings and put forward shareholder proposals to have the company halt the practice. His proposal did not pass, but he did not give up easily and started a website to increase pressure on the company. (See http: / / www.sharkonline.org for an article containing more details regarding this issue.)Pepsi has withdrawn bullfighting ads in Mexico but continues with them in Spain. Mr. Hindi continues his quest. Should the proposal have been approved? Does Mr. Hindi run any risk with his website activism?

Question 17

Beginning in March 1981, R. Foster Winans was a Wall Street Journal reporter and one of the writers of the "Heard on the Street" column (the "Heard" column), a widely read and influential column in the Journal. David Carpenter worked as a news clerk at the Journal from December 1981 through May 1983. Kenneth Felis, who was a stockbroker at the brokerage house of Kidder Peabody, had been brought to that firm by another Kidder Peabody stockbroker, Peter Brant, Mr. Felis's longtime friend, who later became the government's key witness in this case.
Since February 2, 1981, it had been the practice of Dow Jones, the parent company of the Wall Street Journal, to distribute to all new employees "The Insider Story," a 40-page manual with 7 pages devoted to the company's conflicts-of-interest policy. Mr. Winans and Mr. Carpenter knew that company policy deemed all news material gleaned by an employee during the course of employment to be company property and that company policy required employees to treat nonpublic information learned on the job as confidential.
Notwithstanding company policy, Mr. Winans participated in a scheme with Mr. Brant, and later Mr. Felis and Mr. Carpenter, in which he agreed to provide the two stockbrokers (Mr. Brant and Mr. Felis)with securitiesrelated information that was scheduled to appear in "Heard" columns; based on this advance information, the two brokers would buy or sell the subject securities. Mr. Carpenter, who was involved in a private, personal, nonbusiness relationship with Mr. Winans, served primarily as a messenger for the conspirators. Trading accounts were established in the names of Kenneth Felis, David Carpenter, R. Foster Winans, Peter Brant, David Clark, Western Hemisphere, and Stephen Spratt. During 1983 and early 1984, these defendants made prepublication trades on the basis of their advance knowledge of approximately 27 Wall Street Journal "Heard" columns, although not all of those columns were written by Mr. Winans. Generally, he would inform Mr. Brant of an article's subject the day before its scheduled publication, usually by calls from a pay phone and often using a fictitious name. The net profits from the scheme approached $690,000. Was this scheme a 10(b)violation? [ United States v Carpenter, 791 F.2d 1024 (2d Cir. 1986); affirmed, Carpenter v United States, 484 U.S. 19 (1987)]

Question 18

Following the collapse of the World Trade Center (WTC)in New York City on September 11, 2001, the stock markets were closed for several days. When the stock markets reopened on Monday, September 17, 2001, there was unusual activity in stocks that were hit the hardest by the attacks and subsequent shut-down of the United States' airline industry: airlines and insurance. Investors based in Europe has purchased puts in airline and insurance companies with the expectation of earning returns based on the fall in these companies' share prices.
Puts work as follows: A company sells 1,000,000 put options on its stock (trading at $100 per share)exercisable at $100 within a month or two months or one year. Investors buy the puts at $10 a share. Company pockets $10,000,000 in cash.
When the put date arrives: If the stock price is $100 or more, the puts expire worthless. Company A has made $10,000,000. If the stock price drops to $50, the investor can buy shares at $50 and exercise the puts. Company A must buy back the shares at $100. The company loses $50 million less its $10 million for a net loss of $40 million.
In the case of the WTC disaster, someone with advance knowledge of the attacks, by buying puts, bet that the stocks of these companies would go down. They were correct, and the SEC placed a hold on the payments to the put holders as investigators looked into trading on inside information and tracing the links of those who bought the puts. Would advance knowledge of the attacks be a form of inside information? Would buying with that advance knowledge be a violation of 10(b)? What about the fact that they were foreign investors?

Question 19

Vincent Chiarella was employed as a printer in a financial printing firm that handled the printing for takeover bids. Although the firm names were left out of the financial materials and inserted at the last moment, Mr. Chiarella was able to deduce who was being taken over and by whom from other information in the reports being printed. Using this information, Mr. Chiarella was able to dabble in the stock market over a 14-month period for a net gain of $30,000. After an SEC investigation, he signed a consent decree that required him to return all of his profits to the sellers he purchased from during that 14-month period. He was then indicted for violation of 10(b)of the 1934 act and the SEC's Rule 10b-5. Did Mr. Chiarella violate 10b-5? [ Chiarella v United States , 445 U.S. 222 (1980)]