Class 3/4 Flashcards
what is the leverage effect?
The leverage effect suggests that as a company takes on more debt or financial leverage, its profitability or stock returns become more sensitive to changes in its operating performance. (can amplify returns and losses)
What are some costs of disclosure?
- preparation (deciding what to disclose)
- dissemination (how to disclose)
- over and under inclusion can lead to litigation
- over disclosure can bury investors in info
- disclosure to some parties can hurt investors (competitors, government etc)
Materiality - what is the law?
I. Rule 10b-5 (in connection with the purchase or sale of any security)
- it shall be unlawful for any person, directly or indirectly, by the use of any means or instrumentality of interstate commerce, or of the mails or of any facility of any national securities exchange
(b) to make any UNTRUE STATEMENT OF A MATERIAL FACT OR TO OMIT TO STATE A MATERIAL FACT necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading
II. SA Rule 408 and SEA Rule 12b-20 (registration statements and reports)
Further material info must be added if any as may be necessary to make statements not misleading.
III. Item 101 of Regulation S-K (description of business)
- issuers must describe the business of the registrant, its subsidiaries and any predecessors during the past five years, info shall be disclosed for earlier periods if MATERIAL to an understanding of the general development of the business.
Do you have to disclose material omissions?
No, you don’t have to disclose omissions even if material
- omissions become actionable when their exclusion makes a disclosure incomplete.
TSC Industries
what is the Materiality standard?
info is material if there is a SUBSTANTIAL LIKELIHOOD that the disclosure would have been viewed by the REASONABLE INVESTOR as having significantly altered the TOTAL MIX of information made available.
It has to be IMPORTANT to the reasonable shareholder, but it DOESN’T have to be shown that the reasonable shareholder would CHANGE his vote.
What is securitization?
Securitization is a financial process where illiquid assets, typically loans or receivables are pooled together and converted into tradable securities. They are transferred to a SPV. They are then sold to investors and can be traded on the secondary market.
What is pooling of assets?
The originator, which could be a bank, financial institution, or other entity, gathers a pool of similar types of assets, such as mortgages, auto loans, credit card receivables, or even future cash flows from leases.
What is SPV?
Special Purpose Vehicle. A separate legal entity created solely for the purpose of holding and managing the assets. The SPV issues securities backed by these assets.
US v. Litvak (materiality -Reasonable investor)
Facts:
Litvak worked for broker-dealer Jefferies & Co. Traded bonds and acted as the middle man.
Norris worked for Invesco.
BWIC= bids wanted in competition
Norris Expressed interest in buying a bond (anything under 80)
Litvak took bids to find the best price.
Litvak found a price of 79-16 ($79 + 16/32=$.50)
He said the price was 79-24 ($79.75)
I: did Litvak have to disclose the secret price?
Was he an agent with duties?
If not, did he have a duty to disclose?
Was this Material? who is a reasonable investor?
H: vacated the conviction and remanded.
Reasoning:
Policy: if we listen to individuals about their beliefs, materiality will be a subjective not objective standard and will be a moving target
Would the decision be different if Litvak had represented himself as the Norris agent?
Probably. (but why?)
Between inventory trades, order trades, and BWIC trades how would these markets change if the broker-dealers were not arms length?
Probably less inventory trades and more order trades, as they would want to be less like dealers and more like brokers getting fees.
Why is confidentiality so important in M & A?
preserving value. if news of a potential merger or acquisition leaks, it could affect the perceived value of the companies involved.
Basic Inc. v. Levinson (materiality- forward-looking info)
Facts:
combustion had interest in acquiring Basic.
there was heavy trading in the stock.
Basics president denied trading was due to merger negotiations three times.
At announcement, Basic suspended trading and stated support for the deal.
Shareholders that sold after the statements but before the announcement sued.
I: Does the manager/board have to disclose ongoing merger negotiations?
Can the manager/ board lie about discussions?
Rules from other circuits:
cert granted to resolve the split.
Reasoning: The court focused on the fact that the deal completion is uncertain.
However, the agreement in principal is not necessarily the line between low and high certainty. (while simple, investors and managers are sophisticated enough to understand whats material).
The 6th circuit misses that materiality is a matter
of magnitude not type of disclosure.
The Judge Friendly analysis seem logical. Basically take a PV of the info.
Materiality threshold as a discounted value:
Disclose if ($ value of event) x (prob. of event) > = X
What is the objective tests of materiality? SEC securities accounting bulletin No. 99
The use of a percentage as a numerical threshold, such as 5%, may provide the basis for a preliminary assumption that–without considering all relevant circumstances– a deviation of less than the specified percentage with respect to a particular item on the registrants financial statements in unlikely to be material.
Financial management and the auditor must consider both QUANTITATIVE and QUALITATIVE factors in assessing an items materiality.
What is a segment?
separate business operations in a firm (can have separate reporting requirements)
