ACG 5075 KU Business The Importance of Budgetary Planning Presentation

Description

Create a presentation based on the week 7 paper.Budget Planning
Juan Pacini
Keiser University
Dr. George E. Febres, PhD
ACG5075 Accounting for Decision Makers
October 13, 2023
BUDGET PLANNING
2
Budget Planning
Budgetary planning is a fundamental component in business since it [provides managers
and financial decision-makers with a framework necessary for good financial decision-making.
Ideally, a financial plan is essential for this procedure to be effective, and it entails factors like
resource allotments and forecasts of revenues. In addition, through effective budget planning, the
managers and financial leaders can come up with good decisions useful in the organization,
ensuring an effective communication mode. Also, accountability among the individuals involved
is created, and new changes are accepted through adapting very fast (Paramasivan, 2009). On
that note, we will explore the importance of budgetary planning, look at the various types of
budgets available and applied by different organizations, discuss the challenges experienced in
budgetary planning, and discuss the advantages of good budget planning.
Importance of Budgetary Planning
Budgetary planning systematically establishes specific, quantifiable financial goals that
will serve as the organization’s compass points. These objectives ensure that everyone in the
company knows the direction and reason behind their financial efforts. Without clear objectives,
financial actions and decisions may become haphazard, which may result in inefficiencies and
lost opportunities (Sullivan et al., 2014).
Budgetary planning and financial decisions ensure the organization’s broad goal and
strategic vision. It bridges the gap between the organization’s stated mission and the practical
procedures needed to achieve financial success. The organization’s strategic position in the
market or industry is reinforced by ensuring that financial resources are allocated in a way that
reinforces the organization’s main objective.
BUDGET PLANNING
3
Maintaining accountability within the organization is one of budgetary planning’s most
important roles (Sullivan et al., 2014). It accomplishes this by outlining explicitly the financial
obligations and performance standards. The budget is divided among the many departments,
teams, and people, each given a set of financial objectives. Roles and duties are clearly defined,
promoting an environment of openness and accountability where workers know how their work
affects the organization’s financial health. This accountability, in turn, motivates people to take
charge of their financial responsibilities and work hard to accomplish or surpass their goals.
By providing pertinent stakeholders with easy access to financial data, budget planning
also promotes transparency. It enables staff members at all levels to understand the company’s
financial situation and how their activities affect its bottom line. Since employees are more likely
to make responsible financial decisions once they have control over budgetary information, this
transparency goes hand in hand with a sense of responsibility. As a result, the company gains
from the workforce’s shared commitment to preserving and increasing its financial stability.
Effective budgetary planning is characterized by efficient resource allocation. It makes
sure that the money is widely distributed across numerous departments, initiatives, or projects.
Budgetary planning maximizes the utilization of resources by examining the needs, objectives,
and prospective returns on investment. Ideally, this optimization is essential to maximize the
company’s overall effectiveness and competitiveness since it stops resources from being wasted
on initiatives with declining returns.
Planning your finances is another aspect of risk minimization. Organizations can better
handle unforeseen obstacles by predicting financial demands, allocating funds for emergencies,
and spotting potential financial traps. They can react swiftly and efficiently to financial crises or
recessions because of their risk awareness, limiting potential harm.
BUDGET PLANNING
4
Ideally, budgeting planning is essential for businesses that want to traverse the
complexity of today’s business environments successfully. It offers a plan for accomplishing
financial objectives and fosters a culture of accountability, responsibility, and openness.
Additionally, it ensures that money is used wisely to help the organization achieve its goals and
mission. In the end, efficient budgetary planning is a potent instrument that equips businesses to
succeed while remaining flexible and resilient in the face of various challenges.
Types of Budgets
Budgetary planning describes several different budgets, each of which addresses a
particular area of a business’s financial operations. Firstly, we have the master budget, a
comprehensive financial plan that is the cornerstone of a business’ budgetary planning process. It
incorporates every other budget, providing a thorough analysis of the company’s financial plan.
Examples of some of the many components that typically make up the overall budget include the
operational, capital, and cash budgets. A manufacturing company, for example, can incorporate
budgets for manufacturing, marketing, advertising, and scientific research into the master budget
to ensure that all aspects of the company’s financial status are by its strategic goals.
The operating budget, on the other hand, is primarily concerned with the organization’s
continuous operations. It concentrates on upcoming, frequent fiscal year, income, and spending
projections. Forecasts for the year’s anticipated sales revenues, cost of goods sold, operating
expenses, and net profitability can all be found in an operational budget for a retail business. The
organization can frequently evaluate its financial performance with the aid of this budget and
make the required adjustments to keep its financial viability.
Contrarily, a capital budget is intended for strategic planning and investment. It helps
businesses allocate funds for important capital investments like purchasing new machinery,
BUDGET PLANNING
5
building new buildings, or undertaking extensive research and development initiatives. A capital
budget might be used, for instance, by a technology company aiming to create a new product line
to calculate the expenses of the machinery needed for R&D and production. By wisely allocating
cash, the organization can explore development prospects while maintaining its financial
stability.
The Cash Budget focuses on controlling the organization’s cash flows. It forecasts the
business’ anticipated monthly or quarterly cash flow for a given period. A small business, for
instance, can use a cash budget to plan when it needs to pay suppliers and when consumers will
pay their invoices. By doing this, the company makes sure that it always has enough cash on
hand to cover its debts and avoid liquidity problems. The cash budget is especially important for
businesses like retail stores or service providers that run efficiently on steady cash flow (Almaree
et al., 2015).
Each of these different budget types has a specific function in aiding the company in
achieving its financial goals, making them crucial elements of the budgetary planning process for
organizations. The operating, capital, and cash budgets offer more detailed insights into the
organization’s ongoing operations, future investments, and cash management techniques than the
master budget, which offers a holistic perspective. These budgets work together to create a
coherent framework that helps people make financial decisions and promotes economic stability
and growth.
Steps in Budgetary Planning
The financial management process contains several sequential phases that go into creating a
successful budget.
BUDGET PLANNING

6
Establishing Financial Goals
Organizations must create clear, attainable, and realistic financial goals before
beginning budgeting planning. These goals act as the cornerstone on which the budget is
built. An example of a financial objective might be for a charitable organization to raise
15% more money over the upcoming fiscal year. This objective gives the budgeting
process a clear direction and directs future budgetary choices and resource allocations
(Frow et al., 2010).

Estimating Revenues.
The other fundamental stage in budgeting planning is accurately anticipating
revenues. Projecting predicted income from sources including sales, grants, investments,
and fundraising is a requirement for organizations. For instance, estimating sales income
for a retail company’s budget would entail using historical data, current market
conditions, and sales projections. Organizations can decide how to distribute resources
and pay for costs by clearly grasping predicted revenues.

Allocating resources
Another fundamental phase is the resource allocation phase, which involves
deciding how financial resources will be distributed across various departments, projects,
or initiatives. The organization’s strategic priorities should guide this action. For instance,
a manufacturing company may allocate a large portion of its budget to R&D if innovation
is a key strategic goal. Thus, this makes it possible for the organization to effectively
move toward its overall goals by ensuring its financial resources are by those goals and
priorities.
BUDGET PLANNING

7
Monitoring and Controlling
After establishing the budget, it is crucial to analyze financial performance continuously.
Ideally, this entails comparing actual results with the planned figures, detecting deviations, and
implementing necessary corrective steps to guarantee alignment with financial objectives. For
instance, it would be required to reevaluate and modify resource allocation or cost-cutting
methods if an organization’s budget expected a specific amount of savings on expenses through
efficiency improvements, but actual spending exceeded those estimates.
Budgetary control also includes routinely examining cash flow reports, financial records,
and key performance indicators (KPIs) to determine whether the company is on pace to reach its
financial goals. Prompt remedial action can help the firm return to its financial objectives if
disparities do occur.
Challenges in Budgetary Planning
Although undoubtedly advantageous, budgeting provides a challenging environment that
firms must successfully manage. Firstly, the Revenue Projections’ Uncertainty. The inherent
uncertainty in revenue estimates is one of the biggest problems in budgetary planning.
Organizations frequently need help with the issue of effectively estimating revenues since the
state of the economy can be very uncertain. A manufacturing company, for instance, can find it
challenging to forecast sales income due to shifting market dynamics, shifting client preferences,
and outside influences like economic downturns. It is difficult to predict financial inflows with
accuracy when there are so many unknowns that could have a substantial impact on revenue
sources. Organizations must use reliable forecasting models considering various scenarios and
market factors to overcome this difficulty (Leskaj, 2017).
BUDGET PLANNING
8
Second, resistance to financial restrictions. Implementing budget restrictions can
frequently run into opposition from various sources inside an organization. Department and
employees may see budget restrictions as a barrier to effectively achieving their goals. It might
be difficult to strike the right balance between the need for budgetary responsibility and various
groups’ operational requirements and goals. For instance, the marketing division might push for a
bigger budget to spend on marketing initiatives, while the finance division wants to keep
expenditures under control. To overcome this obstacle, good negotiation, communication, and a
shared comprehension of the organization’s broad financial goals and limitations are necessary.
Thirdly, precise cost estimation. Accurately estimating costs is difficult, especially in
large, complicated businesses with many cost centers. When costs are overestimated, resources
may not be used to their full potential, resulting in wasteful spending. On the other hand,
underestimating expenses can lead to budget shortfalls, endangering the company’s ability to
fulfill its financial commitments and goals. For instance, a healthcare provider may need help
forecasting operational expenses due to changes in regulatory requirements, staffing needs, and
healthcare cost fluctuations. Careful cost studies, the use of historical data, and consideration of
prospective cost drivers will be used to improve expense projections to overcome difficulties.
External factors come in third. External factors frequently make budget planning challenging.
These outside factors may significantly impact the stability of an organization’s finances. For
instance, recessions spurred on by the COVID-19 pandemic can cause even the best-planned
budgets to go awry. Decreased consumer demand, supply chain issues, and currency exchange
rate variations may impact a firm.
Additionally, fiscal changes could be necessary in reaction to legislative amendments,
including changes to tax laws or regulations. Natural catastrophes like hurricanes, earthquakes,
BUDGET PLANNING
9
and wildfires can inflict enormous financial damage, demanding the unanticipated allocation of
resources by organizations for recovery efforts. To lessen the effects of external factors,
organizations should integrate risk assessment and emergency planning into their financial
processes.
Benefits of Effective Budgetary Planning
A well-planned budget has many benefits that improve an organization’s overall success
and financial stability. These advantages come in many forms and are crucial in determining how
a corporation handles its finances. Ideally, an organized structure for financial decision-making
inside an organization is provided by budgetary planning. In assessing the financial sustainability
of projects or initiatives, it acts as a thorough financial roadmap for managers and decisionmakers. The budget, for instance, might be used by a retail company evaluating the introduction
of a new product line to evaluate the venture’s prospective costs, revenue outlook, and
profitability. Thus, this minimizes the possibility of expensive mistakes by ensuring that
financial decisions are based on a complete grasp of their repercussions (Marglin, 2014).
Budgetary planning also ensures that financial resources are distributed wisely according
to the organization’s strategic aims. This optimization ensures the efficient and effective
utilization of resources. A technological corporation, for instance, can devote a bigger budget to
innovation initiatives if it has a strategic focus on research and development. By doing this, it
maximizes the effectiveness of resource allocation and allocates money to projects that directly
support the expansion and competitiveness of the company.
Budgetary planning also ensures that financial resources are distributed wisely according
to the organization’s strategic aims. This optimization ensures the efficient and effective
utilization of resources. A technological corporation, for instance, can devote a bigger budget to
BUDGET PLANNING
10
innovation initiatives if it has a strategic focus on research and development. By doing this, it
maximizes the effectiveness of resource allocation and allocates money to projects that directly
support the expansion and competitiveness of the company (Marglin, 2014).
Budgetary planning includes ongoing monitoring and variance analysis, which helps
businesses keep control of their finances. Organizations can see possible financial problems early
by routinely inspecting financial accounts, financial reports, and key performance indicators
(KPIs). For instance, it indicates a possible issue and necessitates urgent corrective action if
actual spending continually exceeds anticipated estimates. Through proactive management of
their finances, businesses can stop problems from worsening and reduce financial risks.
Lastly, good budgetary planning is innately adaptable and flexible, allowing companies
to modify their financial plans in response to shifting external conditions. Organizations may
need to adjust their budgets during a global economic crisis to consider decreased customer
demand or supply chain disruptions. Effective budgetary planning enables scenario analysis and
the creation of backup plans, assisting businesses in remaining adaptable and receptive to
shifting market conditions.
CONCLUSION
In conclusion, budgetary planning is firmly entrenched in successful business financial
management. Its extraordinary ability to set exact financial targets, create wise resource
allocations, and improve accountability across the board gives it utmost importance. The benefits
of excellent budgetary planning for an organization’s financial stability, long-term viability, and
overall performance must be considered despite potential obstacles, including revenue
uncertainty, resistance to limitations, and the complexity of spending estimation. A wellexecuted budgeting strategy acts as a compass, enabling firms to survive and prosper in the
BUDGET PLANNING
11
current business environment. It continues to be a vital instrument for assisting businesses in
achieving their financial goals and their long-term viability in a fast-paced and cutthroat business
environment. Budgetary planning continues to be a bulwark that enables enterprises to navigate
their financial ship toward success and resilience in an era of rapid change and unpredictability.
BUDGET PLANNING
12
Reference
Almaree, K. E. M. P., Bowman, A., Berenice, B. L. O. M., Visser, C., Bergoer, D., Fullard, D.,
… & Bruwer, J. P. (2015). The usefulness of cash budgets in micro, very small, and small
retail enterprises operating in the Cape Metropolis. Expert Journal of Business and
Management, 3(1). https://business.expertjournals.com/23446781-302/
Frow, N., Marginson, D., & Ogden, S. (2010). “Continuous” budgeting: Reconciling budget
flexibility with budgetary control. Accounting, Organizations and Society, 35(4), 444461. https://www.sciencedirect.com/science/article/abs/pii/S0361368209001007
Leskaj, E. (2017). The challenges faced by the strategic management of public
organizations. Revista» Administratie si Management Public «(RAMP), (29), 151-161.
https://www.ceeol.com/search/article-detail?id=728405
Marglin, S. A. (2014). Public investment criteria (routledge revivals): Benefit-cost analysis for
planned
economic
growth.
Routledge.
https://books.google.co.ke/books?hl=en&lr=&id=n33ZBAAAQBAJ&oi=fnd&pg=PP1&
dq=+Benefits+of+Effective+Budgetary+Planning&ots=gLWvaAnTue&sig=eeCdZmvV
AQkZOIBCiG38HCMnyI&redir_esc=y#v=onepage&q=Benefits%20of%20Effective%20Budgetary%20Pla
nning&f=false
Paramasivan,
C.
(2009). Financial
management.
New
age
international.
https://books.google.co.ke/books?hl=en&lr=&id=rs8OHkkVTyIC&oi=fnd&pg=PA1&dq
=+A+key+component+of+financial+management+in+businesses+is+budgetary+planning
&ots=vvkKCmMuIe&sig=kaUr_GW0BZeY1uS592BCi1LCNQ&redir_esc=y#v=onepage&q=A%20key%20component%2
BUDGET PLANNING
13
0of%20financial%20management%20in%20businesses%20is%20budgetary%20planning
&f=false
Sullivan, S. D., Mauskopf, J. A., Augustovski, F., Caro, J. J., Lee, K. M., Minchin, M., … &
Shau, W. Y. (2014). Budget impact analysis—principles of good practice: report of the
ISPOR 2012 Budget Impact Analysis Good Practice II Task Force. Value in
health, 17(1),
https://www.sciencedirect.com/science/article/pii/S1098301513042356
5-14.

Purchase answer to see full
attachment

ACG 5075 KU Business The Importance of Budgetary Planning Presentation

FIN 4220 Business Return on Equity & Operating Cash Flow Question

Description

Only complete only Deliverable one from the attached case.MACRS TABLE
Year
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
21
22
23
24
25
26
27
28
29
30
31
32
33
34
35
36
37
38
39
40
41
3-year
33.33%
44.45%
14.81%
7.41%
100%
5-year
20%
32%
19.20%
11.52%
11.52%
5.76%
100%
7-year
14.29%
24.49%
17.49%
12.49%
8.93%
8.93%
8.93%
4.45%
100%
10-year
10%
18%
14.40%
11.52%
9.22%
7.37%
6.55%
6.55%
6.56%
6.55%
3.28%
100%
15-year
5%
9.50%
8.55%
7.70%
6.93%
6.23%
5.90%
5.91%
5.90%
5.90%
5.91%
5.90%
5.91%
5.90%
5.91%
2.95%
100%
20-year
3.75%
7.22%
6.68%
6.18%
5.71%
5.29%
4.89%
4.52%
4.46%
4.46%
4.46%
4.46%
4.46%
4.46%
4.46%
4.46%
4.46%
4.46%
4.46%
4.46%
2.23%
100%
40-year
3.28%
3.63%
3.49%
3.36%
3.23%
3.11%
3.00%
2.88%
2.78%
2.67%
2.57%
2.48%
2.38%
2.29%
2.25%
2.25%
2.25%
2.25%
2.25%
2.25%
2.25%
2.25%
2.25%
2.25%
2.25%
2.25%
2.25%
2.25%
2.25%
2.25%
2.25%
2.25%
2.26%
2.25%
2.25%
2.25%
2.25%
2.25%
2.25%
2.25%
0.28%
100%
Case Study – FIN 4220
Arôme Botanique
Arôme Botanique in Rancho Santa Margarita, California, was started in 2012 by Alexa
Soto. She grew up with a mother who collected natural handmade aromatics and
mixed different scents to create her own perfumes. Alexa fell in love with the fragility
and power of smell. After receiving her Master’s degree in Botany at UC Berkley, Alexa
was fortunate to be able to start her own business, producing coveted essential oils
used in the perfume industry.
Alexa initially invested in 15 acres of land and planted various selected flowers and
herbs. Alexa started out by selling her crops to large fragrance manufacturers. As time
went by, she began extracting and producing her own natural essential oils, establishing
Arôme Botanique (AB) as a successful leader in natural scents in the United States.
Arôme Botanique now produces several concentrated essential oils. Among them,
rose, lavender, tuberose, gardenia, bergamot orange, clary sage, helichrysum,
spearmint, chamomile and jasmine. The oils are extracted from plants through a
process of distillation and cold pressing. The oils are sold to the fragrance industry
where they are blended into fragrance compositions to make perfume. While Arôme
Botanique has an excellent reputation in the market as a natural organic grower and
producer of essential oils, it is still a relatively small company. As the demand for natural
products increases, Alexa believes that her company has an opportunity to capitalize on
market trends and grow.
After many strategic meetings, Arôme Botanique has agreed that it would be willing to
invest $3,000,000 in the fixed assets needed to generate additional sales. AB has
identified 5 potential investment projects which could all help grow the business to the
next level. Your consulting services have been retained to conduct an analysis of the
proposed projects and formulate a final proposal that will:
(a) Identify which projects will create the most value for Arôme Botanique
(b) explain the strategy behind the proposal
(c) propose an optimal capital structure addressing how those capital investments
should be funded.
AB has a 21% corporate tax rate (assume no taxes if EBT is negative) and a required
rate of return of 10%.
1
DELIVERABLES:
1. Your case study should begin with an Executive Summary page, detailing your
recommendations (1 paragraph) and a table showing a summary of each of the
project’s NPV and IRR. Example:
2. Your first task is to calculate CFFA, CFS, and CFC, IGR (Internal Growth Rate),
and SGR (Sustainable Growth Rate) for Arôme Botanique, using the latest
financial statements available. Based on your calculations, address AB’s current
growth potential.
3. Review and analyze each proposed investment, using NPV and IRR. Set up a
detailed cash flow table showing total cash flows for each year of the project.
Use Excel to run your NPV/IRR and copy/insert your Excel Cash Flow table into
your Word document. Example:
4. Based on your analysis, prepare a capital expenditure plan of action for the AB
management team. (Explain which projects you are recommending they fund, in
what order, and why). Be sure to respect AB’s total capital investment limit ($3
million).
5. Propose an optimal capital structure that will address the funding of the
expansion. (Debt? Equity? Mix of both?)
6. Perform a short sensitivity analysis: come up with a (reasonable) worst case
scenario for the Fragrance Experience project. Detail your assumptions. What
would happen to NPV and IRR? Would this worst case scenario change your
recommendations?
2
LATEST FINANCIAL INFORMATION
3
1.Expansion Project
A 5-acre heavily forested piece of land next to AB’s property is for sale and AB would
like to acquire it. AB has already performed an extensive soil analysis, which cost
$12,000. It concluded that the land has soil fit to grow Boronia Mega Stigmas. The land
is valued at $140,000 per acre. It would cost an additional $80,000 to partially clear and
level the ground. Partial clearing will create the shade needed for the Boronia shrubs to
prosper. The land will not depreciate as it is expected to grow in value over time.
Boronias Mega Stigma is a more difficult flower to grow. It comes from a fragrant shrub
native of Australia. Adding Boronia essential oil to its product line would allow AB to not
only diversify its scents but also enter the premium fragrance industry. Essence of
Boronia M. is rare in the fragrance industry and is therefore one of the priciest oils.
Boronia M. has a scent reminiscent of raspberry, apricot, violet and yellow freesia.
AB does not anticipate being able to harvest any of the flowers in the first year of
operations. Consequently, AB will not be able to initially recognize any sales until year
2, when the garden is estimated to start producing 2 tons of boronia per acre. Each ton
will translates into 40 cases of perfume, each containing 12 bottles of essential oil. The
Boronias M. crop will take 5 years to fully mature. Every year after year 2, the flower
production per acre will increase by 20% until year 6 when it will be at full bloom
capacity and stay at that level.
Initially, AB is anticipating selling each bottle for $65. As the crop matures, AB believes
that it will be able to ramp up the price per bottle by 15% every year until year 6, at
which point the sales price will stabilize. Since Boronias M. is in great demand in the
perfume industry, it is estimated that 100% of the bottles produced will be sold each
year.
4
If AB goes through with planting Boronia Mega Stigma, tools and equipment will be
needed to grow this flower. Alexa has found a nearby organic vegetable farmer willing to
sell his used equipment for $290,000. The equipment includes 2 Kubota tractors, 3
Woods rototillers and several lawn drop spreaders. This equipment is expected to have
a 10-year life and will require $3,000 of annual maintenance. The equipment will have
no resale value at the end of the 10 years and will be depreciated straight-line to zero.
AB will also have to invest in special wind barriers to protect the shrubs, extra hoes,
rakes, and digging forks. This will represent a $50,000 one-time expense. These tools
will not be depreciated.
Because AB’s processing equipment is currently running at full capacity, AB will also
have to invest in the additional production equipment needed to extract and bottle the
essential oil. They will need to invest in the following:
Quantity Needed
Description
Price per Unit
1
Stem Trimming Machine
$19,995
2
Oil Extraction Machine
$4,200
3
Oil Chiller
$9,250
1
Oil bottling Machine
$12,500
All of this production equipment will be depreciated for 10 years using SL depreciation
to zero. After 10 years, the stem trimming, oil extraction, oil chiller and bottling machines
will be worth 20% of their original price. AB plans to re-evaluate this project after 10
years.
5
Labor: AB will need to hire 2 full-time gardeners, with a starting salary of $16 an hour.
The gardeners will be hired right away and will be under the supervision of AB’s Master
Gardener. In year 2, AB will have to hire a fragrance maker starting at $75,000 a year
and a full-time fragrance production worker ($16 an hour). AB plans to increase salaries
by 4% each year.
Other Direct Costs of Goods Sold: AB has estimated that running the garden and
providing supplies necessary for the production and bottling of the fragrance oil will cost
approximately $6.57 per bottle.
NWC: this project will tie up an additional $60,000 in NWC.
2. Create a Fragrance Experience
AB’s fragrance oils are very popular in California and the line of essential oils is carried
by many retail stores who love to feature natural products made in California. Alexa
believes that AB’s popularity would lend itself well to opening a store on its premises
that would offer a destination “Fragrance Experience” to its customers.
The Fragrance Experience would consist of 3 parts:
1. Customers would be taken on a tour of the gardens where they would be
introduced to the various types of flowers and plants grown in AB’s fields and the
different types of oils and aromas they create.
2. After the garden tour, they would participate in a hands-on Scent Blending
Workshop. A fragrance specialist would introduce customers to the 4 main
categories of fragrances and 12 core families. Customers would then be able to
select the oils needed to make their own perfume: a carrier oil, a base essential
oil, and head and heart essential oils. Customers would then follow a prescribed
mixing sequence to create their own perfume. Each customer will walk away with
a sample-sized bottle of the perfume they created. The cost of the sample bottle
is included in the price of the workshop.
3. Upon completion of the workshop, customers would have the option to sit down
and have some refreshments and snacks at the café on the premises. There,
they would also be able to purchase Arôme Botanique essential oils to take
home.
This Fragrance Experience is expected to become a popular activity, especially among
tourists who come to California to visit the NAPA valley and hold bachelor/bachelorette
parties.
6
In order to create this experience for its customers, AB would have to expand its
building to create several workshop rooms, add a check-in area room with shelves of
essential oils for sale, a small café where natural teas/coffees and pastries will be
served. AB will also have to pave a portion of its land to create a parking lot large
enough to accommodate touring coaches and buses. The value of the land needed for
the building expansion and parking lot is estimated at $350,000. The total construction
cost is estimated at $450,000. The special purpose building/parking lot is expected to
be depreciated using 40-year MACRS depreciation. There is no resale value for the
building expansion.
The furniture/fixtures and equipment for the café and workshop rooms will cost about
$140,000, and will be depreciated using 7-year MACRS depreciation. Furniture/fixtures
and equipment are estimated to have a 20% market value at the end of year 5.
For this project, AB will buy 2 Diamond VIP2800 buses that will be used to take
customers around the property as they tour the fields and gardens. Each bus is
estimated to cost $129,800. In addition, AB will equip each bus with a good Jensen
audio system which is estimated to cost $1,500 per bus. Buses and audio equipment
will be depreciated using a 5-year MACRS depreciation. At the end of year 5, AB
believes that the buses and audio systems will still have a market value of 45% of their
original cost.
AB has estimated that it will cost $10,000 annually in gas and maintenance to run the
tours and maintain the workshop rooms and café. This cost will increase by 15% every
year.
7
AB is also planning to pay a design firm to create signage for their workshop building
and for a billboard. The one-time cost of the new signage is expected to be $50,000,
which will be expensed.
Labor: AB would hire a cashier/receptionist ($55,000), 2 fragrance specialists who will
lead the tours and workshops ($65,000 each), 2 bus drivers ($30,000 each), a barista
and a baker for the cafe (each making $16 an hour). Salaries are expected to increase
by 3% in years 2 and 3, and 4% thereafter.
AB is committed to running this project for 5 years, at which point the management
team will evaluate the viability of the tours/workshops.
AB expects the following sales in its first year.
Revenue Category
Price per customer
Quantity
Garden Tour & Fragrance
Workshop
$165
2,600
Cafe
$30
2,200
Essential Oil Bottles
$60
1,200
AB expects the number of tours/workshops to increase by 15% in year 2, 20% in year
3, and 10% in each of years 4 and 5. The price per tour/workshop will increase to $190
in year 3 and will remain at that level until Year 5.
Café sales are anticipated to grow every year. Both quantity and price are estimated to
grow by 10% every year. AB is estimating that it will cost them $12 for coffee/tea and
baking supplies for every sale. The cost of the café supplies are estimated to grow by
5% every year.
The number of essential oil bottles sold will increase by 15% every year, and the price
per bottle will increase by 10% every year.
AB is estimating that it will need to supply 10 bottles of essential oils per 100 workshop
customers. The direct cost of goods sold is $6.57 per bottle. Of course, AB is aware
that diverting the bottles of oil to be sold in the store to workshop customers will affect
their current sales. AB will not be able to sell those bottles through their regular
channels, at the traditional price of $40. An allowance will need to be made for this.
8
An investment of $75,000 in additional working is anticipated.
3.EcoSmarte Drip Irrigation
AB currently uses a spray irrigation system for their 15 acres of flowers. This system is
not the most accurate and AB suspects that it is currently wasting a good amount of
water.
While every farm deals with yield losses, flowers typically have a higher yield loss if not
cared for or irrigated properly. AB has been looking for a new irrigation system that will
be more accurate and more efficient than their current spray system and have selected
the EcoSmarte drip irrigation system.
The EcoSmarte drip irrigation system applies the irrigation water directly to the roots of
the flower bushes. The amount of water dispensed can be regulated to fit the needs of
each type of flower bush, based on size and moisture need. This system uses pumps
that oxygenate and ionize the water, removing excess iron and manganese. This step
helps promote plan growth and increases the water holding capacity of the soil.
In order to install the EcoSmarte system, AB will have to invest in irrigation lines and
pumps. It will cost $25,500 per acre to purchase the irrigation lines. Installation fees will
be $5,000 per acre. The irrigation lines have a life expectancy of 5 years, at which point
they will have no resale value and will need to be replaced. They will be depreciated
using straight-line depreciation to zero over 5 years.
9
The irrigation system will be powered by solar irrigation pumps. AB will need to buy and
install one pump for every acre. A pump will cost $40,000 and installation/connection
costs per pump will be $1,500. The solar powered pumps are estimated to have a 15%
resale value at year 5. They will be depreciated using a MACRS 7-year depreciation
schedule. The pumps will need to be serviced, cleaned and restocked with electrolytes
every 6 months, at a cost of $675 per pump. The electrolyte powder supply needed to
ionize the water will cost AB $25,000 a year, with the expectation that the price will
increase by 10% every year.
If AB decides to invest in this drip irrigation system, it will sell its existing spray irrigation
system for $15,000. The existing irrigation system is fully depreciated to zero.
The EcoSmarte watering system will reduce the amount of water used, which will
translate into annual savings of $3,500 per acre. It will also increase the yield of flowers
per acre. AB estimates that it loses a total of 25% of total flowers due to spotty watering
under the current irrigation system. AB’s current flower per acre yield (5 tons) can be
increased by 1.25 tons per acre. 1.25 tons of flowers produces 1,280,000 flower petals.
It takes 1,600 flower petals to make 1 essential oil bottle. AB sells 1 bottle of essential
oil for $40.
AB’s existing machinery has the capacity to process the additional oil that will be
generated under this project, so each additional bottle of essential oil is expected to
carry the same CGS of $6.57.
AB will test this system over a period of 5 years to see if the flower output increases as
anticipated. At that point, a determination will be made as to whether or not to replace
the irrigation lines. This project will require an additional investment of $50,000 in net
working capital.
10
4. All Natural Hand Soap Product Line
Alexa believes that the target market of natural essential oils and perfumes is also
looking for all-natural hand soap products. Modern consumers have become more
conscious of how they impact the environment and how store-bought soaps impact their
health and their families. Many of the retail stores that AB works with have expressed a
desire to carry organic soap products.
Alexa would like to start a new line of soap products, scented with AB’s essential oils.
In order to do so, AB will need to invest in the following equipment:
• 2 stainless steel liquid soap tank mixers to make the soap products. Each
will cost $80,000. Shipping and installation will add another $3,000 per
mixer.
• A stainless steel 550 gallon storage tank with temperature controls will
store excess soap until it is ready to be packaged. The tank will cost
$4,650. Installation will require adding a line from the tank to the filler
machine, which will cost of $2,000.

A rotary volumetric piston filling machine dedicated to fill viscous liquids
for personal and home care, at a cost of $52,700. Shipping and
installation will add another $3,000. Annual maintenance on this machine
is expected to be $2000 a year since the filling heads need to be
thoroughly cleaned multiple times during the year. Maintenance costs will
increase by 10% every year.
11
The mixers, tank and filling machine will all be depreciated using the 7-year MACRS
depreciation schedule. At the end of year 8, AB will make a determination as to whether
or not to continue this product line. At that time, AB will be able to sell the equipment for
15% of its original price.
AB believes that it will be able to manufacture and sell 500 cases of hand soap the first
year. A case of hand soap will sell for $360 in years 1-3. The sales price is expected to
jump to $420 for years 4-8. AB expects case sales to increase by 20% the 2nd year, and
15% every year thereafter until it reaches capacity in year 6.
AB anticipates using 2 bottles of essential oils per case of soap. An allowance will need
to be made for the fact that these bottles will no longer be sold at the usual $40 per
bottle.
Since soap products require lye, stabilizers, essential oils, bottles and other packaging,
the COGS per case is estimated to be $85. CGS are anticipated to increase by 10%
every year.
Labor: the start of a new product line will require 2 new workers. These workers will be
managing the manufacturing and packaging of these products at a starting salary of $20
an hour. Their pay is planned to increase by 4% each year
The new product line will require and additional $20,000 in Net Working Capital.
5. Signature Fragrances
So far, AB has concentrated on producing essential oils for the perfume market. AB
believes that it might be time to create its own natural signature fragrances from the oils
it produces. In order to create a signature fragrance, AB would have to hire a talented
12
artisan/chemist with experience in the scent industry. The artisan would create several
fragrances that would be tested in the local market. The goal is to launch 3 signature
fragrances upon the completion of the test study. The new fragrances would be rolled
out in phases in various geographical markets, starting with the California and Oregon
markets.
Initially, AB will buy the lab equipment needed for the artisan/chemist to create
fragrance samples:









(1) 16’ by 4’ laboratory island with center shelf for $15,280
(1) Stainless steel 23cu. Ft laboratory refrigerator, $3,765
(1) Computer system with BioExplorer software, $3,500
(1) 800W distillation kit with Borosilicate glassware, $810
(1) Botanical extractor, $350
(1) Vortex mixer, $500
(2) Decompression apparatus, $150, each
(3) Laboratory glassware, $600, each
(3) Benchtop dryers, single sided, $150 each
The lab island and refrigerator will be depreciated using 7-year MACRS. At the end of
year 8, both the island and refrigerator will have a market value equal to 10% of the
original purchase price.
The computer and SW will be depreciated using 3-year MACRS, with zero residual
value.
The extractor, distillation kit and mixer will be depreciated using 3-year MACRS and will
not have any residual value.
All other lab equipment will be expensed when purchased and will be replenished
every 2 years.
AB is hoping to start producing its signature fragrances in year 3, so it will need to buy
the following dedicated equipment in year 2:
(3) Stainless steel mixing machines with horizontal ribbon mixer, $25,000 each,
requiring installation of $2,000 each
(3) Automatic perfume sealer machines with crimping collar ring pressing
capabilities, $7,000 each
13
The mixing machines and sealer machines will be depreciated using the 7-year MACRS
schedule. They are expected to be worth 20% of their initial cost at the end of year 8.
The machines will be maintained on an annual basis at a cost of $2,000. Maintenance
costs are expected to increase by 10% every year.
In year 3, AB is hoping to produce and sell 3,000 bottles of signature fragrances at a
price of $75. The signature fragrances will be marketed as clean, organic and non-toxic.
The direct costs associated with producing 1 bottle of fragrance are estimated at $22
per bottle, and include the fragrance mix, coumarin (the perfume base the oil
fragrances will be mixed with), bottle, diffuser spray mechanism, label and packaging.
AB estimates that it will need to use 2 bottles of essential oil for every 10 bottles of
signature fragrance.
Labor: AB will hire a fragrance artisan/chemist in year 1 with a salary of $69,300. Once
production starts, AB will hire a mixologist and a bottler in year 3. The mixologist will be
paid $45,000 and the bottler $32,000. AB is planning to increase salaries by 3% every
year.
Additional NWC in the amount of $20,000 will be needed to support this new product
line. AB would like to evaluate the feasibility of this project over an 8 year period.
14

Purchase answer to see full
attachment

FIN 4220 Business Return on Equity & Operating Cash Flow Question

Business Teams and Tools the Teams Stage of Maturity Discussion

Description

Watch the following video that distinguishes the differences between groups and teams:
Groups in the Workplace
Groups and teams are used in the workplace in support of meeting company objectives. People must understand the different team types that are used in business and how they mature through their growth process.
Given the different types of teams, along with understanding their maturity stages, companies must be able to support team performance.
Based on your research and experience, discuss the following with your classmates:

Based on your experiences working in teams, what are the different types of teams?
From your experiences, how does the team’s stage of maturity (Tuckman Model) impact team cohesion and performance?
How can sociotechnical tools impact a team’s performance? Share your experiences

Business Teams and Tools the Teams Stage of Maturity Discussion

SDSU Business Law Pursuing Insider Trading Cases Discussion

I’m working on a business law discussion question and need the explanation and answer to help me learn.

Review the summary of United States v. Newman, 773 F.3d 438 (2d Cir. 2014) in Chapter 45
Review Chapter 45
Review the following scenario. 

Ken Hastings is hosting a backyard cookout for some of his neighbors. One of the invitees is Steve Chen, whose wife, Judith Chen, is the CEO of New World Industries. During the cookout, Steve received a call from his wife, who is out of town on business.
Upon returning to the barbecue after the call, Steve’s demeanor has clearly changed and he seems unusually happy. Ken and Tim Daniels listen to what Steve reports. Steve tells his neighbors that Judith was out of town working on a very important settlement, and that her efforts have paid off.
Assume Ken Hastings (cookout host) and Tim Daniels (Ken’s tennis partner) both bought stock in New World Industries as soon as the market opened on Monday and all profited 30% after the press announcement by Mrs. Chen. Pursuant to their agreement, Tim Daniels paid Ken Hasting 5% of the profit he made on the transaction.

With regard to Judith Chen, Steve Chen, Ken Hastings and Tim Daniels, which of these parties could be considered an “insider” under rule 10(b)(5) of the Securities Act of 1934? Explain why or why not.
Which of these parties could have tipper or tippee liability in this case?
Did Judith Chen’s actions in telling her husband about the settlement breach her fiduciary duty?
Who actually obtained a personal benefit from the tip and how?1
MODERN SECURITIES REGULATION AROSE from the rubble of the great stock market
crash of October 1929. After the crash, Congress studied its causes and discovered several
common problems in securities transactions, the most important ones being:
1.Investors lacked the necessary information to make intelligent decisions whether to buy,
sell, or hold securities.
2.Disreputable sellers of securities made outlandish claims about the expected performance of
securities and sold securities in nonexistent companies.
Faced with these perceived problems, Congress chose to require securities sellers to disclose
the information that investors need to make intelligent investment decisions. Congress found
that investors are able to make intelligent investment decisions if they are given sufficient
information about the company whose securities they are to buy. This disclosure scheme
assumes that investors need assistance from government in acquiring information but that
they need no help in evaluating information.
Purposes of Securities Regulation
LO45-1Understand why and demonstrate how the law regulates issuances and issuers of
securities.
To implement its disclosure scheme, in the early 1930s Congress passed two major statutes,
which are the hub of federal securities regulation in the United States today. These two
statutes, the Securities Act of 1933 and the Securities Exchange Act of 1934, have three basic
purposes:
1.To require the disclosure of meaningful information about a security and its issuer to allow
investors to make intelligent investment decisions.
2.To impose liability on those persons who make inadequate and erroneous disclosures of
information.
3.To regulate insiders, professional sellers of securities, securities exchanges, and other selfregulatory securities organizations.
The crux of the securities acts is to impose on issuers of securities, other sellers of securities,
and selected buyers of securities the affirmative duty to disclose important information, even
if they are not asked by investors to make the disclosures. By requiring disclosure, Congress
hoped to restore investor confidence in the securities markets. Congress wanted to bolster
investor confidence in the honesty of the stock market and thus encourage more investors to
invest in securities. Building investor confidence would increase capital formation and, it was
hoped, help the American economy emerge from the Great Depression of the 1930s.
2
Congress has reaffirmed the purposes of the securities law many times since the 1930s by
passing laws that expand investor protections. Most recent are the enactments of the
Sarbanes—Oxley Act of 2002 and the Dodd—Frank Wall Street Reform and Consumer
Protection Act of 2010. The Sarbanes—Oxley Act was a response to widespread
misstatements and omissions in corporate financial statements, which led to accounting fraud
scandals at high-profile public companies. Many public investors lost their life savings in the
collapses of firms like Enron and WorldCom, while insiders profited. As we learned in
Chapters 4 and 43 and will learn in this chapter and Chapter 46, the Sarbanes—Oxley Act
imposes duties on corporations, their officers, and their auditors and provides for a Public
Company Accounting Oversight Board to establish auditing standards.
The Dodd—Frank Act, enacted in the wake of the financial crisis of 2007, mostly regulates
banks and consumer credit institutions. While this subject matter is outside the scope of the
chapter, what is covered here and in Chapters 43 and 46 are the Dodd—Frank Act’s
provisions that impose new powers and responsibilities on the Securities and Exchange
Commission, increase regulation of brokers and investment advisers, regulate asset-backed
securities, require shareholder approval of executive compensation, and strengthen
shareholder rights in director elections.
page 45-3
LOG ON

Welcome to the Securities Lawyer’s Deskbook


The Securities Lawyer’s Deskbook is maintained by the Robert S. Marx Law Library at the
University of Cincinnati College of Law. You can find the text of all the federal securities
statutes and SEC regulations.
Securities and Exchange Commission
The Securities and Exchange Commission (SEC) was created by the 1934 Act. Its
responsibility is to administer the 1933 Act, 1934 Act, and other securities statutes. Like
other federal administrative agencies, the SEC has legislative, executive, and judicial
functions. Its legislative branch promulgates rules and regulations; its executive branch brings
enforcement actions against alleged violators of the securities statutes and their rules and
regulations; its judicial branch decides whether a person has violated the securities laws.
3
SEC Actions The SEC is empowered to investigate violations of the 1933 Act and 1934 Act
and to hold hearings to determine whether the acts have been violated. Such hearings are held
before an administrative law judge (ALJ), who is an employee of the SEC. The
administrative law judge is a finder of both fact and law. Decisions of the ALJ are reviewed
by the commissioners of the SEC. Decisions of the commissioners are appealed to the U.S.
Court of Appeals. Most SEC actions are not litigated. Instead, the SEC issues consent orders,
by which the defendant promises not to violate the securities laws in the future but does not
admit to having violated them in the past.
The SEC has the power to impose civil penalties (fines) up to $500,000 and to issue cease
and desist orders. A cease and desist order directs a defendant to stop violating the securities
laws and to desist from future violations. Nonetheless, the SEC does not have the power to
issue injunctions; only courts may issue injunctions. The 1933 Act and the 1934 Act
empower the SEC only to ask federal district courts for injunctions against persons who have
violated or are about to violate either act. The SEC may also ask the courts to grant ancillary
relief, a remedy in addition to an injunction. Ancillary relief may include, for example, the
disgorgement of profits that a defendant has made in a fraudulent sale or in an illegal insider
trading transaction. In recent years, the SEC’s disgorgement remedy has been limited,
however. The Supreme Court ruled in Kokesh v. SEC1 that disgorgement is a penalty subject
to a five-year statute of limitations. And the Court also held in Liu v. SEC2 that when
disgorgement is sought as equitable relief, it may not exceeding the wrongdoer’s net profits.
Figure 45.1 A Note on Lucia v. SEC
In 2018, the Supreme Court heard a case, Lucia v. SEC, 138 S. Ct. 2044 (2018), that
challenged the very nature of the SEC’s functions. Six years prior, the SEC charged
Raymond Lucia with violating the antifraud provisions of the Investment Advisers Act and
other SEC rules. It was alleged that Lucia, an investment professional, misled potential
investors in roughly 40 different retirement-planning seminars. The case was assigned to one
of the SEC’s five ALJs, who was appointed by SEC staff. The ALJ heard nine days of
testimony, ultimately finding that Lucia had violated the Act; he recommended Lucia pay a
$300,000 fine and be barred for life from the investment industry. On appeal to the SEC,
Lucia argued not only that the decision was wrong on the merits, but that the ALJ was
invalidly appointed and therefore lacked authority to convene a hearing, much less issue a
binding decision, in his case. The question became whether the SEC’s five ALJs were
“Officers of the United States” or “mere employees”; if they were officers, their appointment
was subject to the Appointments Clause of the Constitution and they could not be validly
appointed by SEC staff.
Justice Kagan, writing for the 6-3 majority, found that the ALJs were officers. “Far from
serving temporarily or episodically, SEC ALJs ‘receive[] a career appointment.’ And that
appointment is to a position created by statute, down to its ‘duties, salary, and means of
4
appointment.’” Justice Kagan further stated that “ALJs exercise the same ‘significant
discretion’ when carrying out the same ‘important functions’ as [special trial judges in tax
court, which were found to be officers under Freytag v. Commissioner, 501 U.S. 868
(1991)].” Accordingly, Lucia’s case was remanded for a rehearing by a validly appointed
ALJ. More importantly, the Court’s ruling called into question the appointment of some
1,900 ALJs across various federal agencies, who have collectively heard hundreds of
thousands of cases. The SEC, though, made a quick fix—it reappointed its ALJs itself (as
opposed to staff doing it) and thus solved the Appointments Clause issue. What long-term
effects the Lucia decision will have beyond the SEC remains to be seen.
page 45-4
To reduce the risk that a securities issuer’s or other person’s behavior will violate the
securities law and result in an SEC action, anyone may contact the SEC’s staff in advance,
propose a transaction or course of action, and ask the SEC to issue a no-action letter. In the
no-action letter, the SEC’s staff states it will take no legal action against the issuer or other
person if the issuer or other person acts as indicated in the no-action letter. Issuers often seek
no-action letters before making exempted offerings of securities and excluding shareholder
proposals from their proxy statements, issues we discuss later in the chapter. Because a noaction letter is issued by the SEC’s staff and not the commissioners, it is not binding on the
commissioners. Nonetheless, issuers that comply with no-action letters rarely face SEC
action.
What Is a Security?
LO45-2Define a security and apply the definition to a variety of contracts.
The first issue in securities regulation is the definition of a security. If a transaction involves no
security, then the law of securities regulation does not apply. The 1933 Act defines the term security
broadly:
Unless the context otherwise requires the term “security” means any note, stock, treasury stock,
security future, security-based swap, bond, debenture, evidence of indebtedness, certificate of
interest or participation in any profit-sharing agreement, . . . preorganization certificate or
subscription, . . . investment contract, voting trust certificate, . . . fractional undivided interest in oil,
gas, or mineral rights, any put, call, straddle, option, or privilege on any security, . . . or, in general,
any interest or instrument commonly known as a “security” . . . or warrant or right to subscribe to or
purchase, any of the foregoing.
The 1934 Act definition of security is similar but excludes notes and drafts that mature not more
than nine months from the date of issuance.
5
While typical securities like common shares, preferred shares, bonds, and debentures are defined as
securities, the definition of a security also includes many contracts that the general public may
believe are not securities. This is because the term investment contract is broadly defined by the
courts. The Supreme Court’s three-part test for an investment contract, called the Howey test, has
been the guiding beacon in the area for more than 50 years.3 The Howey test states that an
investment contract is an investment of money in a common enterprise with an expectation of
profits solely from the efforts of others.
In the Howey case, the sales of plots in an orange grove along with a management contract were
held to be sales of securities. The purchasers had investment motives (they intended to make a
profit from, not to consume, the oranges produced by the trees). There was a common enterprise
because the investors provided the capital to finance the orange grove business and shared in its
earnings. The sellers, not the buyers, did all of the work needed to make the plots profitable.
In other cases, sales of limited partnership interests, Scotch whisky receipts, and restaurant
franchises have been held to constitute investment contracts and, therefore, securities. Even
partnership interests in an ordinary partnership have been held to be securities, when the partner is
a passive investor with no meaningful control over the management of the partnership.4
Courts define in two ways the common enterprise element of the Howey test. All courts permit
horizontal commonality to satisfy the common enterprise requirement. Horizontal commonality
requires that investors’ funds be pooled and that profits of the enterprise be shared pro rata by
investors. Some courts accept vertical commonality, in which the investors are similarly affected by
the efforts of the person who is promoting the investment.
Courts have used the Howey test to hold that some contracts with names of typical securities are
not securities. The courts point out that some of these contracts possess few of the characteristics of
a security. For example, in United Housing Foundation, Inc. v. Forman,5 the Supreme Court held that
although tenants in a cooperative apartment building purchased contracts labeled as stock, the
contracts were not securities. The “stock” possessed few of the typical characteristics of stock and
the economic realities of the transaction bore few similarities to those of the typical stock sale: The
stock gave tenants no dividend rights or voting rights in proportion to the number of shares owned,
it was not negotiable, and it could not appreciate in value. More important, tenants bought the
stock not for the purpose of investment but to acquire suitable living space.
However, when investors are misled to believe that the securities laws apply because a seller sold a
contract bearing both the name of a typical security and significant characteristics of that security,
the securities laws do apply to the sale of the security. The application of this doctrine page 45-5led
to the Supreme Court’s rejection of the sale-of-business doctrine, which had held that the sale of
100 percent of the shares of a corporation to a single purchaser who would manage the corporation
was not a security. The rationale for the sale-of-business doctrine was that the purchaser failed to
meet the third element of the Howey test because he expected to make a profit from his own efforts
6
in managing the business. Today, when a business sale is affected by the sale of stock, the
transaction is covered by the securities acts if the stock possesses the characteristics of stock.
In 1990, the Supreme Court further extended this rationale in Reves v. Ernst & Young,6 adopting the
family resemblance test to determine whether promissory notes were securities. The Supreme Court
held that it is inappropriate to apply the Howey test to notes. Instead, applying the family
resemblance test, the Court held that notes are presumed to be securities unless they bear a “strong
family resemblance” to a type of note that is not a security.
The five characteristics of notes that are not securities are:
1.There is no recognized market for the notes.
2.The note is not part of a series of notes.
3.The buyer of the note does not need the protection of the securities laws.
4.The buyer of the note has no investment intent.
5.The buyer has no expectation that the securities laws apply to the sale of the note.
Types of notes that are not securities include consumer notes, mortgage notes, short-term notes
secured by a lien on a small business, short-term notes secured by accounts receivable, and notes
evidencing loans by commercial banks for current operations.
In the following case, the Supreme Court applied the family resemblance test.
Nye Capital Appreciation Partners, L.L.C. v. Nemchik
483 F. App’x 1 (6th Cir. 2012)
In the mid-1990s, the Nyes began making equity investments in ProPaint Plus Automobile Repairs,
Systems & Services Inc. (ProPaint), a company founded by James Johnson and Jackie Nemchik.
Between December 1996 and January 1997, Nemchik hired Roy Malkin as ProPaint’s chief operating
officer and president. In May 1997, Randy Nye became a member of ProPaint’s board of directors.
After Malkin was hired, ProPaint determined it needed capital to make the company viable and to
continue business operations. Malkin, Joseph Carney, and members of ProPaint’s board of directors
prepared a private placement memorandum (PPM) in order to produce new investors. The PPM
failed to produce new investors by March 1998, so the Nyes offered to provide an $800,000 capital
infusion to ProPaint in exchange for 40 percent of ProPaint’s total stock in a form substantially the
same as that being offered through PPM. Pursuant to this agreement, the Nyes agreed to sell shares
in Nye Capital Appreciation Partners, L.L.C. (Nye Capital), an entity the Nyes created to gather
7
investors to make equity payments in ProPaint, and use the capital raised to invest in ProPaint.
ProPaint agreed to repay the Nyes $800,000 and used the remaining capital for business activities.
Between March and October 1998, the Nyes, in the name of Nye Financial Group Inc. (Nye
Financial), transferred a $607,000 “loan” to ProPaint. In October 1998, the Nyes raised $223,000
through Nye Capital and invested it in shares of ProPaint stock.
ProPaint continued to suffer losses through the fall of 1998. On November 15, 1998, Malkin
submitted his resignation. On December 4, 1998, Randy Nye became ProPaint’s chairman and senior
executive and became more involved in the day-to-day operations of ProPaint. Through his
involvement, Randy Nye became aware of alleged misconduct by Malkin, and shortly after, ProPaint
ceased operations and filed for bankruptcy.
The Nyes filed a complaint that asserted various claims arising out of alleged fraudulent
misrepresentations that led to the loss of the money they provided ProPaint. Malkin, Nemchik, and
the Johnsons then filed a motion for summary judgment to dismiss, asserting that the Nyes’ claims
involved the sale of securities and were time-barred. In response, the Nyes filed an opposition to the
summary judgment motions. They contended that the transfer of $607,000 to ProPaint constituted a
loan, not a purchase or sale of securities. They argued that the claims were not time-barred because
they were subject to a longer statute of limitations applicable to common law tort claims. page 456However, the district court granted the motions for summary judgment of the complaint on the
ground that these claims were intertwined with the sale of securities and were, therefore, timebarred by the applicable statutes of limitations and repose.
On appeal, the Nyes contended that the district court erred in determining that their claims were
intertwined with the purchase or sale of securities. They argued that their $607,000 cash infusion
constituted “the mere making of a loan and an issuance of a promissory note.”
Alarcón, Judge
To determine whether a “note” is a security, this court applies the “family resemblance” test
articulated by the United States Supreme Court in Reves v. Ernst & Young, 494 U.S. 56, 110 S. Ct. 945
(1990). Under this test, every note is presumed to be a security, unless it falls into one of the few
enumerated categories. Reves, 494 U.S. at 65. It is undisputed that the $607,000 loan does not fall
within an enumerated category that rebuts the presumption that a note is a security.
If a note does not bear a strong resemblance to one of the enumerated categories, then courts may
still weigh the following four factors to determine whether a note should be added to the list of
categories of non-securities: (1) “the motivations that would prompt a reasonable seller and buyer
to enter into the transaction”; (2) “the ‘plan of distribution’ of the instrument”; (3) “the reasonable
expectations of the investing public”; and (4) “whether some factor such as the existence of another
8
regulatory scheme significantly reduces the risk of the instrument, thereby rendering application of
the Securities Acts unnecessary.” Id. at 66—67.
With respect to the first factor, “if the seller’s purpose is to raise money for the general use of a
business enterprise or to finance substantial investments and the buyer is interested primarily in the
profit the note is expected to generate, the instrument is likely to be a ‘security.’” The Appellees
sought the cash infusion to enable ProPaint to continue operating its business. The Nyes transferred
the money to acquire stock in ProPaint and to generate profit by selling stock to outside investors.
Accordingly, the district court did not err in determining that the first factor weighs in favor of
characterizing the loan as a security.
In applying the second factor, we look to the record to “determine whether it is an instrument in
which there is ‘common trading for speculation or investment.’” Id. However, even if an instrument
is not commonly distributed, “it is clear that paradigmatic securities, such as stocks, can be offered
and sold to a single person, while yet remaining securities.” Bass v. Janney Montgomery Scott, Inc.,
210 F.3d 577, 585 (6th Cir. 2000). Here, the Appellees used the PPM to generate equity interest from
the Nyes. The PPM explicitly stated that the “investment in ProPaint is speculative and should be
considered only by those persons who are able to bear the economic risk and could afford a
complete loss of their investment.” Despite the absence of common trading for speculation or
investment, this solicitation of capital in exchange for stock also weighs in favor of characterizing the
Nyes’ loans as securities.
The record also demonstrates that the third Reves factor is satisfied. The Nyes referred to the
$607,000 transfer to ProPaint as a “loan” but expected to receive stock in ProPaint in exchange and
to convert their “loan” into an equity investment. Randy Nye wrote to Nemchik stating that the
Nyes’ $800,000 capital infusion to ProPaint will “initially take the form of notes and that in exchange
for this funding the investment partnership or LLC will receive 40% of ProPaint.” Carney also stated
in a May 14, 1998 letter to Randy Nye and others, that “if ProPaint were flush with funds, we could
skip the loan step and proceed directly to the investment.” He laid out the steps involved in
converting the loans to equity investments and added “the sooner we get equity issued the better
for ProPaint.”
We reject the Nyes’ assertion that the district court erroneously “relied upon an interpretation of
the evidence” in determining that their loan was intended as an equity investment. The district court
properly reviewed the evidence on the record and “looked to the actual nature or subject matter of
the case, rather than to the form in which the action was plead.” The district court did not err in
determining that the nature of the transaction was a sale of security and that the investing public
would have reasonably perceived it as such.
The final Reves factor is also inapplicable because the Nyes’ loan in exchange for stock in ProPaint
was not collaterized or insured. The PPM warns prospective investors that their investment would
be subject to financial risks, indicating the absence of any security measures. Additionally, the Nyes
9
have not disputed Malkin’s allegation that “the notes at issue here were not protected by any other
regulatory scheme and were uninsured and uncollateralized.” Absent a risk-reducing factor, the
fourth factor supports the characterization of the Nyes’ “loans” as securities.
The balance of the four factors identified in Reves does not support the creation of a new category
of non-securities to encompass the $607,000 loan. The district court did not err in determining that
the Nyes’ loans were securities and that the Nyes’ claims were inextricably intertwined with the sale
of securities.
Securities Act of 1933
LO45-1Understand why and demonstrate how the law regulates issuances and issuers of securities.
The Securities Act of 1933 (1933 Act) is concerned primarily with public distributions of securities.
That is, the 1933 Act regulates the sale of securities while they are passing from the hands of the
issuer into the hands of public investors. An issuer selling securities publicly must make necessary
disclosures at the time the issuer sells the securities to the public.
The 1933 Act has two principal regulatory components: (1) registration provisions and (2) liability
provisions. The registration requirements of the 1933 Act are designed to give investors the
information they need to make intelligent decisions whether to purchase securities when an issuer
sells its securities to the public. The various liability provisions in the 1933 Act impose liability on
sellers of securities for misstating or omitting facts of material significance to investors.
Registration of Securities under the 1933 Act
The Securities Act of 1933 is primarily concerned with protecting investors when securities are sold
by an issuer to investors. That is, the 1933 Act regulates the process during which issuers offer and
sell their securities to investors, primarily public investors.
Therefore, the 1933 Act requires that every offering of securities be registered with the SEC prior to
any offer or sale of the securities, unless the offering or the securities are exempt from registration.
That is, an issuer and its underwriters may not offer or sell securities unless the securities are
registered with the SEC or exempt from registration. Over the next few pages, we will cover the
registration process. Then the exemptions from registration will be addressed.
LO45-3Comply with the communication rules that apply to a public offering of securities.
Mechanics of a Registered Offering
When an issuer makes a decision to raise money by a public offering of securities, the issuer needs
to obtain the assistance of securities market professionals. The issuer will contact a managing
10
underwriter, the primary person assisting the issuer in selling the securities. The managing
underwriter will review the issuer’s operations and financial statements and reach an agreement
with the issuer regarding the type of securities to sell, the offering price, and the compensation to be
paid to the underwriters. The issuer and the managing underwriter will determine what type of
underwriting to use.
In a standby underwriting, the underwriters obtain subscriptions from prospective investors, but the
issuer sells the securities only if there is sufficient investor interest in the securities. The
underwriters receive warrants—options to purchase the issuer’s securities at a bargain price—as
compensation for their efforts. The standby underwriting is typically used only to sell common
shares to existing shareholders pursuant to a preemptive rights offering.
With a best efforts underwriting, the underwriters are merely agents making their best efforts to sell
the issuer’s securities. The underwriters receive a commission for their selling efforts. The best
efforts underwriting is used when an issuer is not well established and the underwriter is unwilling
to risk being unable to sell the securities.
The classic underwriting arrangement is a firm commitment underwriting. Here, the managing
underwriter forms an underwriting group and a selling group. The underwriting group agrees to
purchase the securities from the issuer at a discount from the public offering price—for example, 25
cents per share below the offering price. The selling group agrees to buy the securities from the
underwriters also at a discount—for example, 12½ cents per share below the offering price.
Consequently, the underwriting and selling groups bear much of the risk with a firm commitment
underwriting, but they also stand to make the most profit under such an arrangement.
Securities Offerings on the Internet Increasingly, issuers are using the Internet to make public
securities offerings, especially initial public offerings (IPOs) of companies’ securities. The Internet
provides issuers and underwriters the advantage of making direct offerings to all investors
simultaneously—that is, selling directly to investors without the need for a selling group. The first
Internet securities offering that was approved by the SEC was a firm commitment underwriting.
Internet offerings have increased dramatically since 1998. The Internet is likely to become the
dominant medium for marketing securities directly to investors.
Registration Statement and Prospectus The 1933 Act requires the issuer of securities to register the
securities with the SEC before the issuer or underwriters may offer or sell the securities. Registration
requires filing a registration statement with the SEC. Historical page 45-8and current data about the
issuer, its business lines and the competition it faces, the material risks of the business, material
litigation, its officers’ and directors’ experience and compensation, a description of the securities to
be offered, the amount and price of the securities, the manner in which the securities will be sold,
the underwriter’s compensation for assisting in the sale of the securities, and the issuer’s use of the
proceeds of the issuance, among other information, must be included in the registration statement
prepared by the issuer of the securities with the assistance of the managing underwriter, securities
11
lawyers, and independent accountants. Generally, the registration statement must include audited
balance sheets as of the end of each of the two most recent fiscal years, in addition to audited
income statements and audited statements of changes in financial position for each of the last three
fiscal years.
The registration statement becomes effective after it has been reviewed by the SEC. The 1933 Act
provides that the registration statement becomes effective automatically on the 20th day after its
filing, unless the SEC delays or advances the effective date.
The prospectus is the basic selling document of an offering registered under the 1933 Act. Almost all
of the information in the registration statement must be included in the prospectus. It must be
furnished to every purchaser of the registered security prior to or concurrently with the sale of the
security to the purchaser. The prospectus enables an investor to base her investment decision on all
of the relevant data concerning the issuer, not merely on the favorable information that the issuer
may be inclined to disclose voluntarily.
Although some prospectuses are delivered in person or by mail, most issuers now transmit
prospectuses through their own or the SEC’s website.
LOG ON
Facebook Preliminary Prospectus
To see an example of a preliminary prospectus, a draft registration statement nicknamed a “red
herring” because the SEC requires companies to print in red ink that indicates its preliminary nature,
log on to the SEC’s website and find the 2012 prospectus of Facebook, Inc.
https://www.sec.gov/Archives/edgar/data/1326801/000119312512034517/d287954ds1.htm
Section 5: Timing, Manner, and Content of Offers and Sales The 1933 Act restricts the issuer’s and
underwriter’s ability to communicate with prospective purchasers of the securities. Section 5 of the
1933 Act states the basic rules regarding the timing, manner, and content of offers and sales. It
creates three important periods of time in the life of a securities offering: (1) the pre-filing period,
(2) the waiting period, and (3) the post-effective period.
The Pre-filing Period Prior to the filing of the registration statement (the pre-filing period), the issuer
and any other person may not offer or sell the securities to be registered. The purpose of the prefiling period is to prevent premature communications about an issuer and its securities, which may
12
encourage an investor to make a decision to purchase the security before all the information she
needs is available. The pre-filing period also marks the start of what is sometimes called the quiet
period, which continues for the full duration of the securities offering. A prospective issuer, its
directors and officers, and its underwriters must avoid publicity about the issuer and the prospective
issuance of securities during the pre-filing period and the rest of the quiet period.
Generally, statements made within 30 days of filing a registration statement are considered an
attempt to presell securities during the quiet period. Such “gun jumping” is a violation of Section 5
and may result in liability to the issuer for violating securities laws, a delay of the public offering by
the SEC, and a required disclosure in the prospectus of the potential securities law violations.
Examples of gun jumping include press interviews, participation in investment banker—sponsored
conferences, or new advertising campaigns; all are discouraged during the pre-filing period.
However, the SEC has created a number of safe harbors that allow issuers about to make public
offerings to continue to release information to the public yet not violate Section 5. For example,
under Rule 163A, an issuer can communicate any information about itself so long as it is more than
30 days prior to the filing of a registration statement and two conditions are met: (1) the issuer does
not reference the upcoming securities offering and (2) the issuer takes reasonable steps to prevent
dissemination of the information during the 30-day period before the registration statement is filed.
Rule 135 permits the issuer to publish a notice about a prospective offering during the pre-filing
period. The notice may contain only basic information, such as the name of the issuer, the amount
of the securities offered, a basic description of the securities and the offering, and the anticipated
timing of the offering. It may not name the underwriters or state the price at which the securities
will be offered. A Rule 135 notice is often referred to as a “tombstone” ad. See Figure 45.2.
Securities Act of 1933
LO45-1Understand why and demonstrate how the law regulates issuances and issuers of securities.
The Securities Act of 1933 (1933 Act) is concerned primarily with public distributions of securities.
That is, the 1933 Act regulates the sale of securities while they are passing from the hands of the
issuer into the hands of public investors. An issuer selling securities publicly must make necessary
disclosures at the time the issuer sells the securities to the public.
The 1933 Act has two principal regulatory components: (1) registration provisions and (2) liability
provisions. The registration requirements of the 1933 Act are designed to give investors the
information they need to make intelligent decisions whether to purchase securities when an issuer
sells its securities to the public. The various liability provisions in the 1933 Act impose liability on
sellers of securities for misstating or omitting facts of material significance to investors.
13
Registration of Securities under the 1933 Act
The Securities Act of 1933 is primarily concerned with protecting investors when securities are sold
by an issuer to investors. That is, the 1933 Act regulates the process during which issuers offer and
sell their securities to investors, primarily public investors.
Therefore, the 1933 Act requires that every offering of securities be registered with the SEC prior to
any offer or sale of the securities, unless the offering or the securities are exempt from registration.
That is, an issuer and its underwriters may not offer or sell securities unless the securities are
registered with the SEC or exempt from registration. Over the next few pages, we will cover the
registration process. Then the exemptions from registration will be addressed.
LO45-3Comply with the communication rules that apply to a public offering of securities.
Mechanics of a Registered Offering
When an issuer makes a decision to raise money by a public offering of securities, the issuer needs
to obtain the assistance of securities market professionals. The issuer will contact a managing
underwriter, the primary person assisting the issuer in selling the securities. The managing
underwriter will review the issuer’s operations and financial statements and reach an agreement
with the issuer regarding the type of securities to sell, the offering price, and the compensation to be
paid to the underwriters. The issuer and the managing underwriter will determine what type of
underwriting to use.
In a standby underwriting, the underwriters obtain subscriptions from prospective investors, but the
issuer sells the securities only if there is sufficient investor interest in the securities. The
underwriters receive warrants—options to purchase the issuer’s securities at a bargain price—as
compensation for their efforts. The standby underwriting is typically used only to sell common
shares to existing shareholders pursuant to a preemptive rights offering.
With a best efforts underwriting, the underwriters are merely agents making their best efforts to sell
the issuer’s securities. The underwriters receive a commission for their selling efforts. The best
efforts underwriting is used when an issuer is not well established and the underwriter is unwilling
to risk being unable to sell the securities.
The classic underwriting arrangement is a firm commitment underwriting. Here, the managing
underwriter forms an underwriting group and a selling group. The underwriting group agrees to
purchase the securities from the issuer at a discount from the public offering price—for example, 25
cents per share below the offering price. The selling group agrees to buy the securities from the
underwriters also at a discount—for example, 12½ cents per share below the offering price.
Consequently, the underwriting and selling groups bear much of the risk with a firm commitment
underwriting, but they also stand to make the most profit under such an arrangement.
14
Securities Offerings on the Internet Increasingly, issuers are using the Internet to make public
securities offerings, especially initial public offerings (IPOs) of companies’ securities. The Internet
provides issuers and underwriters the advantage of making direct offerings to all investors
simultaneously—that is, selling directly to investors without the need for a selling group. The first
Internet securities offering that was approved by the SEC was a firm commitment underwriting.
Internet offerings have increased dramatically since 1998. The Internet is likely to become the
dominant medium for marketing securities directly to investors.
Registration Statement and Prospectus The 1933 Act requires the issuer of securities to register the
securities with the SEC before the issuer or underwriters may offer or sell the securities. Registration
requires filing a registration statement with the SEC. Historical page 45-8and current data about the
issuer, its business lines and the competition it faces, the material risks of the business, material
litigation, its officers’ and directors’ experience and compensation, a description of the securities to
be offered, the amount and price of the securities, the manner in which the securities will be sold,
the underwriter’s compensation for assisting in the sale of the securities, and the issuer’s use of the
proceeds of the issuance, among other information, must be included in the registration statement
prepared by the issuer of the securities with the assistance of the managing underwriter, securities
lawyers, and independent accountants. Generally, the registration statement must include audited
balance sheets as of the end of each of the two most recent fiscal years, in addition to audited
income statements and audited statements of changes in financial position for each of the last three
fiscal years.
The registration statement becomes effective after it has been reviewed by the SEC. The 1933 Act
provides that the registration statement becomes effective automatically on the 20th day after its
filing, unless the SEC delays or advances the effective date.
The prospectus is the basic selling document of an offering registered under the 1933 Act. Almost all
of the information in the registration statement must be included in the prospectus. It must be
furnished to every purchaser of the registered security prior to or concurrently with the sale of the
security to the purchaser. The prospectus enables an investor to base her investment decision on all
of the relevant data concerning the issuer, not merely on the favorable information that the issuer
may be inclined to disclose voluntarily.
Although some prospectuses are delivered in person or by mail, most issuers now transmit
prospectuses through their own or the SEC’s website.
LOG ON
Facebook Preliminary Prospectus
15
To see an example of a preliminary prospectus, a draft registration statement nicknamed a “red
herring” because the SEC requires companies to print in red ink that indicates its preliminary nature,
log on to the SEC’s website and find the 2012 prospectus of Facebook, Inc.
https://www.sec.gov/Archives/edgar/data/1326801/000119312512034517/d287954ds1.htm
Section 5: Timing, Manner, and Content of Offers and Sales The 1933 Act restricts the issuer’s and
underwriter’s ability to communicate with prospective purchasers of the securities. Section 5 of the
1933 Act states the basic rules regarding the timing, manner, and content of offers and sales. It
creates three important periods of time in the life of a securities offering: (1) the pre-filing period,
(2) the waiting period, and (3) the post-effective period.
The Pre-filing Period Prior to the filing of the registration statement (the pre-filing period), the issuer
and any other person may not offer or sell the securities to be registered. The purpose of the prefiling period is to prevent premature communications about an issuer and its securities, which may
encourage an investor to make a decision to purchase the security before all the information she
needs is available. The pre-filing period also marks the start of what is sometimes called the quiet
period, which continues for the full duration of the securities offering. A prospective issuer, its
directors and officers, and its underwriters must avoid publicity about the issuer and the prospective
issuance of securities during the pre-filing period and the rest of the quiet period.
Generally, statements made within 30 days of filing a registration statement are considered an
attempt to presell securities during the quiet period. Such “gun jumping” is a violation of Section 5
and may result in liability to the issuer for violating securities laws, a delay of the public offering by
the SEC, and a required disclosure in the prospectus of the potential securities law violations.
Examples of gun jumping include press interviews, participation in investment banker—sponsored
conferences, or new advertising campaigns; all are discouraged during the pre-filing period.
However, the SEC has created a number of safe harbors that allow issuers about to make public
offerings to continue to release information to the public yet not violate Section 5. For example,
under Rule 163A, an issuer can communicate any information about itself so long as it is more than
30 days prior to the filing of a registration statement and two conditions are met: (1) the issuer does
not reference the upcoming securities offering and (2) the issuer takes reasonable steps to prevent
dissemination of the information during the 30-day period before the registration statement is filed.
Rule 135 permits the issuer to publish a notice about a prospective offering during the pre-filing
period. The notice may contain only basic information, such as the name of the issuer, the amount
of the securities offered, a basic description of the securities and the offering, and the anticipated
timing of the offering. It may not name the underwriters or state the price at which the securities
will be offered. A Rule 135 notice is often referred to as a “tombstone” ad. See Figure 45.2.
16
Figure 45.3 Google’s Gun Jumping
A well-known example of a gun-jumping violation of Section 5 was committed by Google, Inc.
Sometime prior to the company’s IPO of August 13, 2004, Google’s founders Sergey Brin and Larry
Page gave an interview to Playboy magazine. The interview was published in the September 2004
issue under the title “Playboy Interview: Google Guys.” Not surprisingly, Brin and Page made
favorable comments about their company but included no mention of the offering or the sale of
securities. In fact, the statements the founders made about the tech company were innocuous, such
as “people use Google because they trust us.”
Nevertheless, the SEC found the interview was gun jumping under Section 5 for violating the quiet
period. Although Google could have been required to buy back shares sold to investors in the IPO at
the original purchase price for a period of one year following the violation, ultimately the company
had to take three remedial actions: (1) revise its prospectus to include a risk factor warning that the
Playboy interview violated Section 5, (2) include the full text of the article in the prospectus; and (3)
address discrepancies between statistics reported in the article and the prospectus.
Note: More recently, Salesforce.com Inc. was forced to delay its IPO after the company and its CEO
Marc Benioff were featured in a flattering New York Times article. The article drew SEC attention
because it included statements from Benioff about his company that were not included in its
registration statement.
The waiting period is an important part of the regulatory scheme of the 1933 Act. It provides an
investor with adequate time to judge the wisdom of buying the security during a period when he
cannot be pressured to buy it. Not even a contract to buy the security may be made during the
waiting period.
The Post-effective Period After the effective date (the date on which the SEC declares the
registration effective), Section 5 permits the security to be offered and also to be sold, provided that
the buyer has received a final prospectus (a preliminary prospectus is not acceptable for this
purpose). Road shows and free-writing prospectuses may continue to be used. Other written offers
not previously allowed are permitted during the post-effective period, but only if the offeree has
received a final prospectus. During the post-effective period, the safe harbors of Rules 134, 135, and
168 and Section 105 of the JOBS Act continue to apply. The Concept Review provides a comparison
of the three important periods of time in the life of a securities offering, as well as some of the
applicable safe harbors.
Liability for Violating Section 5 Section 12(a)(1) of the 1933 Act imposes liability on any person who
violates the provisions of Section 5. Liability extends to any purchaser to whom an illegal offer or
sale was made. The purchaser’s remedy is rescission of the purchase or damages if the purchaser
has already resold the securities.
17
Exemptions from the Registration Requirements of the 1933 Act
LO45-4List and apply the Securities Act’s exemptions from registration.
Complying with the registration requirements of the 1933 Act, including the restrictions of Section 5,
is a burdensome, time-consuming, and expensive process. Planning and executing an issuer’s first
public offering may consume months and cost millions of dollars. Consequently, some issuers prefer
to avoid registration when they sell securities. There are two types of exemptions from the
registration requirements of the 1933 Act: securities exemptions and transaction exemptions.
Securities Exemptions
Exempt securities never need to be registered, regardless who sells the securities, how they are sold,
or to whom they are sold. The following are the most important securities exemptions.7
page 45-13
1.Securities issued or guaranteed by any government in the United States and its territories.
2.A note or draft that has a maturity date not more than nine months after its date of issuance.
3.A security issued by a nonprofit religious, charitable, educational, benevolent, or fraternal
organization.
4.Securities issued by banks and by savings and loan associations.
5.An insurance policy or an annuity contract.
Although the types of securities listed above are exempt from the registration provisions of the 1933
Act, they are not exempt from the general antifraud provisions of the securities acts. For example,
any fraud committed in the course of selling such securities can be attacked by the SEC and by the
persons who were defrauded under Section 17(a) and Section 12(a)(2) of the 1933 Act and Section
10(b) of the 1934 Act.
Transaction Exemptions
The most important 1933 Act registration exemptions are the transaction exemptions. If a security is
sold pursuant to a transaction exemption, that sale is exempt from registration. Subsequent sales,
however, are not automatically exempt. Future sales must be made pursuant to a registration or
another exemption.
The transaction exemptions are exemptions from the registration provisions. The general antifraud
provisions of the 1933 Act and the 1934 Act apply to exempted and nonexempted transactions.
18
The most important transaction exemptions are those available to issuers of securities. These
exemptions are the intrastate offering exemption, the private offering exemption, and the small
offering exemptions.
Intrastate Offering Exemption
Under Section 3(a)(11), an offering of securities solely to investors in one state by an issuer resident
and doing business in that state is exempt from the 1933 Act’s registration requirements. The reason
for the exemption is that there is little federal government interest in an offering that occurs in only
one state. Although the offering may be exempt from SEC regulation, state securities law may
require a registration. The expectation is that state securities regulation will adequately protect
investors.
The SEC has defined the intrastate offering exemption more precisely in Rule 147 and Rule 147A.
Under Rule 147, an issuer must be organized and have its principal place of business in the state
where it offers and sells securities, and those securities can only be offered and sold to in-state
residents. Resale of the securities is limited to persons within the state for six months.
Rule 147A is almost identical to Rule 147 except that it allows offers to be accessible to out-of-state
residents, so long as sales are only made to those in-state and the company has its principal place of
business in-state.
Private Offering Exemption
Section 4(a)(2) of the 1933 Act provides that the registration requirements of the 1933 Act “shall not
apply to transactions by an issuer not involving any public offering.” A private offering is an offering
to a small number of purchasers who can protect themselves because they are wealthy or because
they are sophisticated in investment matters and have access to the information that they need to
make intelligent investment decisions.
To create greater certainty about what a private offering is, the SEC adopted Rule 506. Although an
issuer may exempt a private offering under either the courts’ interpretation of Section 4(a)(2) or
Rule 506, the SEC tends to treat Rule 506 as the exclusive way to obtain the exemption.
Rule 506 Under Rule 506, which is part of Securities Act Regulation D, investors must be qualified to
purchase the securities. The issuer must reasonably believe that each purchaser is either (a) an
accredited investor or (b) an unaccredited investor who “has such knowledge and experience in
financial and business matters that he is capable of evaluating the merits and risks of the prospective
investment.” Accredited investors include institutional investors (such as banks and mutual funds),
wealthy investors, and high-level insiders of the issuer (such as executive officers, directors, and
19
partners). Issuers should have purchasers sign an investment letter or suitability letter verifying that
they are qualified.
An issuer may sell to no more than 35 unaccredited purchasers who have sufficient investment
knowledge and experience; it may sell to an unlimited number of accredited purchasers, regardless
of their investment sophistication.
Each purchaser must be given or have access to the information she needs to make an informed
investment decision. For a public company making a nonpublic offering under Rule 506 (such as
General Motors selling $5 billion of its notes to 25 mutual funds plus 5 other, unaccredited
investors), purchasers must receive information in a form required by the 1934 Act, such as a 10-K or
annual report. The issuer must provide the following audited financial statements: two years’
balance sheets, three years’ income statements, and three years’ statements of changes in financial
position.
For a nonpublic company making a nonpublic offering under Rule 506, the issuer must provide much
of the same page 45-14nonfinancial information required in a registered offering. A nonpublic
company may, however, obtain some relief from the burden of providing audited financial
statements to investors. When the amount of the issuance is $2 million or less, only one year’s
balance sheet need be audited. If the amount issued exceeds $2 million but not $7.5 million, only
one year’s balance sheet, one year’s income statement, and one year’s statement of changes in
financial position need be audited. When the amount issued exceeds $7.5 million, the issuer must
provide two years’ balance sheets, three years’ income statements, and three years’ statements of
changes in financial position. In any offering of any amount by a nonpublic issuer, when auditing
would involve unreasonable effort or expense, only an audited balance sheet is needed. When a
limited partnership issuer finds that auditing involves unreasonable effort or expense, the limited
partnership may use financial statements prepared by an independent accountant in conformance
with the requirements of federal tax law.
Rule 506 prohibits the issuer from making any general public selling effort, unless all the purchasers
are accredited, preventing the issuer from using the radio, newspapers, and television. However,
offers to an individual one-on-one are permitted.
In addition, the issuer must take reasonable steps to ensure that the purchasers do not resell the
securities in a manner that makes the issuance a public distribution rather than a private one.
Usually, the investor must hold the security for a minimum of six months.
In the Mark case, the issuer failed to prove it was entitled to a private offering exemption under Rule
506. The case features the improper use of an investment or suitability letter.
mall Offering Exemptions
20
For example, several SEC rules and regulations permit an issuer to sell small amounts of securities
and avoid registration. Section 3(b)(1) of the 1933 Act permits the SEC to exempt from registration
any offering by an issuer not exceeding $5 million. The Jumpstart Our Business Startups Act (JOBS
Act) amended the 1933 Act in Sections 3(b)(2) and 4(a)(6) to permit the SEC to exempt offerings up
to $1 million, under some conditions. The rationale for these exemptions is that the dollar amount of
the securities offered or the number of purchasers is too small for the federal government to be
concerned with registration. State securities law may require registration, however.
Rule 504 SEC Rule 504 of Regulation D allows a nonpublic issuer to sell up to $5 million of securities
in a 12-month period and avoid registration. Rule 504 sets no limits on the number of offerees or
purchasers. The purchasers need not be sophisticated in investment matters, and the issuer need
disclose information only as required by state securities law. Rule 504 permits general selling efforts,
and purchasers are free to resell the securities at any time but only if the issuer either registers the
securities under state securities law or sells only to accredited investors pursuant to a state
securities law exemption.
Regulation A Regulation A allows issuers to offer and sell securities to the public, but with more
limited disclosure requirements than generally required. The motivation behind the exemption is
that smaller issuers in earlier stages of development may be able to raise money more costeffectively.
Under Regulation A, issuers can raise money under two different tiers. Issuers are required to
indicate the tier under which the offering is being conducted. Tier 1 issuers can raise up to $20
million in any 12-month period, but their offering circular must be filed with the SEC and securities
regulators in the states where the offering is being conducted. The financial statements disclosed are
not required to be audited. There are no limitations on who can invest or how much under Tier 1.
Tier 2 issuers can offer up to $50 million in any 12-month period, and their offering is subject to
review and qualification only by the SEC, but financial statements disclosed must be independently
audited. Tier 2 also limits those who can purchase securities and in what amounts. Accredited
investors are not limited. Unaccredited entities are limited based on annual revenues and net assets.
Unaccredited individual investors can invest up to no more than 10% of the greater of their annual
income or net worth (excluding the value of the person’s primary residence and any loans secured
by the residence).
Regulation A’s disclosure requirements also differ depending on the tier. Issuers relying on Tier 1 do
not have ongoing reporting obligations other than filing a final report on the status of the offering.
Tier 2 issuers have detailed ongoing reporting obligations for various disclosure forms. For example,
an issuer must file an annual report within 120 days after the end of the fiscal year that includes
audited financial statements for the year, a discussion of the company’s financial results for the year,
and information about the company’s business and management, related-party transactions, and
share ownership. Issuers that already publicly report, such as companies that are listed on a stock
21
exchange, will be deemed to have met their Regulation A disclosure obligations by remaining current
in their disclosures.
page 45-16
The JOBS Act and Regulation Crowdfunding The JOBS Act authorizes the SEC to exempt from 1933
Act registration the use of crowdfunding to offer and sell securities. The intent of the JOBS Act is to
make it easier for startups and small businesses to raise capital from a wider range of potential
investors and to provide more investment opportunities for investors. The JOBS Act restricts
crowdfunding to emerging growth companies, that is, those with less than $1 billion in total annual
gross revenues. Investment companies, non-U.S. companies, and companies already required to file
reports under the 1934 Act are not eligible to use the JOBS Act exemptions.
The JOBS Act established the foundation for a regulatory structure that would permit emerging
growth companies to use crowdfunding and directed the SEC to write rules implementing the
exemption. It also created a new entity—a funding portal—to allow Internet-based platforms or
intermediaries to facilitate the offer and sale of securities without having to register with the SEC as
brokers.
Under Regulation Crowdfunding, the regulation flowing from the JOBS Act, an issuer is limited in the
amount of money it can raise to a maximum of $1 million in a 12-month period. Although there are
no limits on the number of investors, individuals are only permitted over the course of a 12-month
period to invest
$2,000 or 5 percent of their annual income or net worth, whichever is greater, if both their annual
income and net worth are less than $100,000 or
10 percent of their annual income or net worth, whichever is greater, if either their annual income
or net worth is equal to or more than $100,000. During the 12-month period, these investors would
not be able to purchase more than $100,000 of securities through crowdfunding.
Regulation Crowdfunding requires an issuer to file certain information with the SEC, provide it to
investors and the broker-dealers or portals facilitating the crowdfunding offering, and make it
available to potential investors. In its offering documents, the issuer must disclose the following:
A description of the issuer’s business and the use of the proceeds from the offering.
Information about the issuer’s officers and directors as well as owners of 20 percent or more of the
issuer’s equity securities.
The price to the public of the securities being offered, the target offering amount, the deadline to
reach the target offering amount, and whether the issuer will accept investments in excess of the
target offering amount.
22
A description of the financial condition of the issuer.
Financial statements of the issuer that, depending on the amount offered and sold during a 12month period, would have to be accompanied by a copy of the issuer’s tax returns or reviewed or
audited by an independent public accountant or auditor.
One of the key investor protections of the JOBS Act is the requirement that crowdfunding
transactions take place through an SEC-registered intermediary: either a broker-dealer or a funding
portal. Under Regulation Crowdfunding, the offerings occur exclusively online through a platform
operated by a registered broker or a funding portal. These intermediaries, then, must
Provide investors with educational materials.
Take measures to reduce the risk of fraud.
Make available information about the issuer and the offering.
Provide communication channels to permit discussions about offerings on the platform.
Facilitate the offer and sale of crowdfunded securities.
The regulation prohibits funding portals from offering investment advice or making
recommendations, soliciting purchases or sales of securities on its website, and holding or
processing investor assets. Regulation Crowdfunding also imposes certain restrictions on
compensating people for solicitations but does allow issuers to make general solicitations to
prospective investors.
Transaction Exemptions for Nonissuers Although it is true that the registration provisions apply
primarily to issuers and those who help issuers sell their securities publicly, the 1933 Act states that
every person who sells a security is potentially subject to Section 5’s restrictions on the timing of
offers and sales. This highlights the most important rule of the 1933 Act: Every transaction in
securities must be registered with the SEC or be exempt from registration.
This rule applies to every person, including the small investor who, through the New York Stock
Exchange, sells securities that may have been registered by the issuer 15 years earlier. The small
investor must either have the issuer register her sale of securities or find an exemption from
registration that applies to the situation. Fortunately, most small investors who resell securities will
have an exemption from the registration requirements of the 1933 Act. The transaction ordinarily
used by these resellers is Section 4(a)(1) of the 1933 Act. It provides an exemption for “transactions
by any person other than an issuer, underwriter, or dealer.”
For example, if you buy GM common shares on the New York Stock Exchange, you may freely resell
them without a page 45-17registration. You are not an issuer (GM is). You are not a dealer (because
you are not in the business of selling securities). And you are not an underwriter (because you are
not helping GM distribute the shares to the public).
23
Application of this exemption when an investor sells shares that are already publicly traded is easy;
however, it is more difficult to determine whether an investor can use this exemption when the
investor sells restricted securities.
Sale of Restricted Securities Restricted securities are securities issued pursuant to regulations that
limit their resale. Restricted securities are supposed to be held by a purchaser unaffiliated with the
issuer for at least six months if the issuer is a public company and one year if the issuer is not public.
If they are sold earlier, the investor may be deemed an underwriter who has assisted the issuer in
selling the securities to the general public. Consequently, both the issuer and the investor may have
violated Section 5 of the 1933 Act by selling nonexempted securities prior to a registration of the
securities with the SEC. As a result, all investors who purchased securities from the issuer in the
exempted offering may have the remedy of rescission under Section 12(a)(1), resulting in the issuer
being required to return to investors all the proceeds of the issuance.
For example, an investor buys 10,000 common shares issued by Arcom Corporation pursuant to a
Rule 506 private offering exemption. One month later, the investor sells the securities to 40 other
investors. The original investor has acted as an underwriter because he has helped Arcom distribute
the shares to the public. The original investor may not use the issuer’s private offering exemption
because it exempted only the issuer’s sale to him. As a result, both the original investor and Arcom
have violated Section 5. The 40 investors who purchased the securities from the original investor—
and all other investors who purchased common shares from the issuer in the Rule 506 offering—may
rescind their purchases under Section 12(a)(1) of the 1933 Act, receiving from their seller the return
of their investment.

Purchase answer to see full
attachment

SDSU Business Law Pursuing Insider Trading Cases Discussion

SDSU Business Law Environmental Regulations and Ethics Discussion

I’m working on a business law discussion question and need the explanation and answer to help me learn.

Browse the United States Environmental Protection Agency’s (EPA’s) Laws & RegulationsLinks to an external site. webpage.
Review Chapter 4

Suppose a manufacturing facility emits into the air a chemical that it has reason to believe is inadequately regulated by the EPA and that poses a significant threat to nearby residents even at levels lower than permitted by the EPA. As manager of the facility, would you be satisfied to meet the EPA required level or would you install the additional controls you believe necessary to achieve a reasonably safe level? Keep in mind that installing these controls would be expensive and you can anticipate resistance from corporate executives as well as shareholders. Explain why or why not. Support your answer with one or more of the ethical theories from Chapter 4.1
Business Ethics, Corporate Social Responsibility, Corporate Governance, and Critical Thinking
What defines ethical behavior? Think of a time when you thought that someone or some business
did something ethical. Was it someone going out of her way to help another person? Was it, for
example, a young man—a customer at a store—helping an elderly woman carry heavy packages
to her car? Was it someone entering a building during a pouring rain and giving her umbrella to a
father and his small children who were waiting to leave until the rain stopped?
Was it a corporate executive speaking for an hour to a friend’s daughter—a young college
student—helping her understand how to seek an internship and prepare for a career in the
executive’s industry? Was it a business giving a second chance to a young man who fell in with
the wrong crowd, made a mistake, and served time in prison?
Was it a company recalling and repairing an allegedly defective product, even when not required
by the government, at great cost to its profits and shareholders? Was it a business that bought a
failing company in the solar industry? Was it a corporation buying a competitor, achieving
synergies, improving options and pricing for consumers, and increasing the company’s profits?
Was it a business that chose to upgrade its factories in a midwestern town instead of moving
manufacturing operations overseas? Was it a business that opened a new plant in Indonesia,
creating jobs for 1,000 workers? Was it a corporation with excess cash opting to increase its
2
dividend by 25 percent and buy back 10 percent of its stock, thereby increasing returns to
shareholders and the price of the shareholders’ stock in the company?
In these and other situations in which you observed what you believed was ethical conduct, what
made you think the behavior was ethical? Was it that the ethical actor obeyed some fundamental
notion of rightness? Was it that the person treated someone the way you would want to be
treated? Was it that the actor gave an opportunity to someone who was in greater need than most
people? Was it that the company helped someone who deserved aid?
Was it that most people thought that it was the right thing to do or that the majority wanted it
done, whether right or not? Was it that the business took full advantage of the resources entrusted
to it by society? Was it that the business helped society use its scarce resources in a productive or
fair way?
What ethical responsibilities do businesses and business leaders have and to whom?
What defines ethical behavior?
page 4-2
3
LO LEARNING OBJECTIVES
After studying this chapter, you should be able to:
4-1Appreciate the strengths and weaknesses of the various ethical theories.
4-2Apply the Guidelines for Ethical Decision Making to business and personal decisions.
4-3Recognize critical thinking errors in your own and others’ arguments.
4-4Utilize a process to make ethical decisions in the face of pressure from others.
4-5Be an ethical leader.
Why Study Business Ethics?
General Motors hiding that it sold cars with faulty ignitions. Target failing to protect customers’
credit card information. Enron maintaining its stock price by moving liabilities off balance sheet.
WorldCom using fraudulent accounting to increase its stock price. ImClone executives and their
family members trading on inside information. These business names and acts from the past two
decades conjure images of unethical and socially irresponsible behavior by business executives.
The U.S. Congress, employees, investors, and other critics of the power held and abused by some
corporations and their management have demanded that corporate wrongdoers be punished and
that future wrongdoers be deterred. Consequently, shareholders, creditors, and state and federal
attorneys general have brought several civil and criminal actions against wrongdoing
corporations and their executives. Congress has also entered the fray, passing the Sarbanes”
Oxley Act of 2002, which increased penalties for corporate wrongdoers and established rules
4
designed to deter and prevent future wrongdoing. The purpose of the statute is to encourage and
enable corporate executives to be ethical and socially responsible.
But statutes and civil and criminal actions can go only so far in directing business managers
down an ethical path. And while avoiding liability by complying with the law is one reason to be
ethical and socially responsible, there are noble and economic reasons that encourage current and
future business executives to study business ethics.
Although it is tempting to paint all businesses and all managers with the same brush that colors
unethical and irresponsible corporations and executives, in reality corporate executives are little
different from you, your friends, and your acquaintances. All of us from time to time fail to do
the right thing, and we know that people have varying levels of commitment to acting ethically.
The difference between most of us and corporate executives is that they are in positions of power
that allow them to do greater damage to others when they act unethically or socially
irresponsibly. They also act under the microscope of public scrutiny.
It is also tempting to say that current business managers are less ethical than managers
historically. But as former Federal Reserve chair Alan Greenspan said, “It is not that humans
have become any more greedy than in generations past. It is that the avenues to express greed
have grown enormously.”
5
This brings us to the first and most important reason we need to study business ethics: to make
better decisions for ourselves, the businesses we work for, and the society we live in. As you read
this chapter, you will not only study the different theories that attempt to define ethical conduct
but, more importantly, learn to use a strategic framework for making decisions. This framework
provides a process for systematic ethical analysis, which will increase the likelihood you have
considered all the facts affecting your decision. By learning a methodology for ethical decision
making and studying common thinking errors, you will improve your ability to make decisions
that build trust and solidify relationships with your business’s stakeholders.
Another reason we study ethics is to understand ourselves and others better. While studying the
various ethical theories, you will see concepts that reflect your own thinking and the thinking of
others. This chapter, by exploring ethical theories systematically and pointing out the strengths
and weaknesses of each ethical theory, should help you understand better why you think the way
you do and why others think the way they do. By studying ethical theories, learning a process for
ethical decision making, and understanding common reasoning fallacies, you should also be
better equipped to decide how you should think and whether you should be persuaded by the
arguments of others. Along the way, by better understanding where others are coming from and
avoiding fallacious reasoning, you should become a more rigorous, critical thinker, as well as
persuasive speaker and writer.
There are also pragmatic reasons for executives to study business ethics. By learning how to act
ethically and by, in fact, doing so, businesses forestall public criticism, reduce lawsuits against
6
them, prevent Congress from passing onerous legislation, and make higher profits. For many
corporate actors, however, these are not reasons to act ethically, but instead the natural
consequences of so acting.
page 4-3
While we are studying business ethics, we will also examine the role of the law and regulations
in defining ethical conduct. Some argue that it is sufficient for corporations and executives to
comply with the requirements of the law; commonly, critics of the corporation point out that
because laws cannot and do not encompass all expressions of ethical behavior, compliance with
the law is necessary but not sufficient to ensure ethical conduct. This introduces us to one of the
major issues in the corporate social responsibility debate.
The Corporate Social Responsibility Debate
Although interest in business ethics education has increased greatly in the last few decades, that
interest is only the latest stage in a long struggle to control corporate misbehavior. Ever since
large corporations emerged in the late 19th century, such firms have been heroes to some and
villains to others. Large corporations perform essential national and global economic functions,
including raw material extraction, energy production, transportation, and communication, as well
as providing consumer goods, professional services, and entertainment to millions of people.
7
Critics, however, claim that in their pursuit of profits, corporations ruin the environment, mistreat
employees, sell shoddy and dangerous products, produce immoral television shows and motion
pictures, and corrupt the political process. Critics claim that even when corporations provide
vital and important services, business is not nearly as accountable to the public as are organs of
government. For example, the public has little to say about the election of corporate directors or
the appointment of corporate officers. This lack of accountability is aggravated by the large
amount of power that big corporations wield in America and throughout much of the world.
These criticisms and perceptions have led to calls for changes in how corporations and their
executives make decisions. The main device for checking corporate misdeeds has been the law.
The perceived need to check abuses of business power was a force behind the New Deal laws of
the 1930s and extensive federal regulations enacted in the 1960s and 1970s. Some critics,
however, believe that legal regulation, while an important element of any corporate control
scheme, is insufficient by itself. They argue that businesses should adhere to a standard of ethical
or socially responsible behavior that is higher than the law.
One such standard is the stakeholder theory of corporate social responsibility. It holds that rather
than merely striving to maximize profits for its shareholders, a corporation should balance the
interests of investors against the interests of other corporate stakeholders, such as employees,
suppliers, customers, and the community. In August 2019, the Business Roundtable endorsed the
stakeholder theory approach, noting the importance of delivering value to customers, investing in
employees, dealing fairly and ethically with suppliers, supporting local communities, and
8
generating long-term value for shareholders. To promote such behavior, some corporate critics
have proposed changes that increase the influence of the various stakeholders in the internal
governance of a corporation. We will study many of these proposals later in the chapter in the
subsection on shareholder theory and its emphasis on profit maximization. You will also learn
later that an ethical decision-making process requires a business executive to anticipate the
effects of a corporate decision on the various corporate stakeholders.
Despite concerns about abuses of power, big business has contributed greatly to the
unprecedented abundance in America and elsewhere. Partly for this reason and partly because
many businesses attempt to be ethical actors, critics have not totally dominated the debate about
control of the modern corporation. Some defenders of business argue that in a society founded on
capitalism, profit maximization should be the main goal of businesses: The only ethical norms
firms must follow are those embodied in the law or those impacting profits. In short, they argue
that businesses that maximize profits within the limits of the law are acting ethically. Otherwise,
the marketplace would discipline them for acting unethically by reducing their profits.
Former Fed chair Alan Greenspan wrote in 1963 that moral values are the power behind
capitalism. He wrote, “Capitalism is based on self-interest and self-esteem; it holds integrity and
trustworthiness as cardinal virtues and makes them pay off in the marketplace, thus demanding
that [business persons] survive by means of virtue, not of vices.” Note that companies that are
successful decade after decade, like Procter & Gamble and Johnson & Johnson, adhere to
society’s core values.
9
We will explore other arguments supporting and criticizing shareholder theory and its emphasis
on profit maximization later in the chapter, where we will consider proposals to improve
corporate governance and accountability. For now, however, having set the stage for the debate
about business ethics and corporate social responsibility, we want to study the definitions of
ethical behavior.
Ethical Theories
For centuries, religious and secular scholars have explored the meaning of human existence and
attempted to define a “good life.” In this section, we will define and examine some of the most
important theories of ethical conduct.
As we cover these theories, much of what you read will be familiar to you. The names may be
new, but almost certainly you have previously heard speeches and read writings of politicians,
religious leaders, and commentators that incorporate the values in these theories. You will
discover that your own thinking is consistent with one or more of the theories. You can also
recognize the thinking of friends and antagonists in these theories.
None of these theories is necessarily invalid, and many people believe strongly in any one of
them. Whether you believe your theory to be right and the others to be wrong, it is unlikely that
others will accept what you see as the error of their ways and agree with all your values. Instead,
it is important for you to recognize that people’s ethical values can be as diverse as human
10
culture. Therefore, no amount of argumentation appealing to theories you accept is likely to
influence someone who subscribes to a different ethical viewpoint. The key, therefore, is to
understand the complexity of ethical perspectives so that you can better understand both your
viewpoint and the viewpoints of others. Only then is it possible to pursue common ground and
provide a rational explanation for the decision that must ultimately be made.
This means that if you want to be understood by and to influence someone who has a different
ethical underpinning than you do, you must first determine her ethical viewpoint and then speak
in an ethical language that will be understood and accepted by her. Otherwise, you and your
opponent are like the talking heads on nighttime cable TV news shows, whose debates often are
reduced to shouting matches void of any attempt to understand the other side.
LOG ON
Go to
www.iep.utm.edu
The Internet Encyclopedia of Philosophy gives you background on all the world’s great
philosophers from Abelard to Zizek. You can also study the development of philosophy from
11
ancient times to the present. Many of the world’s great philosophers addressed the question of
ethical or moral conduct.
The five ethical theories we will highlight are rights theory, justice theory, utilitarianism,
shareholder theory, and virtue theory. Some of these theories focus on results of our decisions or
actions: Do our decisions or actions produce the right results? Theories that focus on the
consequences of a decision are teleological ethical theories. For example, a teleological theory
may justify a manufacturing page 4-5company laying off 5,000 employees because the effect is
to keep the price of manufactured goods low for consumers and to increase profits for the
company’s shareholders.
Other theories focus on the inherent rightness or wrongness of a decision or action itself,
irrespective of what results it produces. This rightness or wrongness can be determined by a rule
or principle or flow from a duty or responsibility. Theories that focus on decisions or actions
alone are deontological ethical theories. For example, a deontological theory may find
unacceptable that any competent employee loses his job, even if the layoff’s effect is to reduce
prices to consumers and increase profits. Or a deontological theory emphasizing the principle
that it is wrong to be dishonest might require that one never tell a lie, regardless of the
consequences. Deontological theories place great emphasis on the duties and responsibilities that
flow from rules, laws, policies, or social norms governing our actions.
12
First, we will cover rights theory, which is a deontological theory. Next will be justice theory,
which has concepts common to rights theory but with a focus primarily on outcomes. Our study
of ethical theories will then turn to two additional teleological theories, utilitarianism and
shareholder theory. Finally, we’ll consider virtue theory, which places the issue of one’s character
and core virtues at the fore, instead of focusing first on rules and responsibilities or the
consequences that inevitably flow from all of our actions.
Rights Theory Rights theory encompasses a variety of ethical philosophies holding that certain
human rights are fundamental and must be respected by other humans. The focus is on each
individual member of society and her rights. As an ethically responsible individual, each of us
faces a moral compulsion not to harm the fundamental rights of others, especially stakeholders
impacted by our business activity.
Kantianism Few rights theorists are strict deontologists, and one of the few is 18th-century
philosopher Immanuel Kant. Kant viewed humans as moral actors who are free to make choices.
He believed humans are able to judge the morality of any action by applying his famous
categorical imperative. One formulation of the categorical imperative is, “Act only on that
maxim whereby at the same time you can will that it shall become a universal law.” This means
that we judge an action by applying it universally.
Suppose you want to borrow money even though you know that you will never repay it. To
justify this action using the categorical imperative, you state the following maxim or rule: “When
13
I want money, I will borrow money and promise to repay it, even though I know I won’t repay.”
According to Kant, you would not want this maxim to become a universal law because no one
would believe in promises to repay debts and you would not be able to borrow money when you
want. The ability to trust others in society would be completely impossible, and relationships
would deteriorate. Thus, your maxim or rule fails to satisfy the categorical imperative. You are
compelled, therefore, not to promise falsely that you will repay a loan.
Kant had a second formulation of the categorical imperative: “Always act to treat humanity,
whether in yourself or in others, as an end in itself, never merely as a means.” Thus arises a rule
or principle creating a duty not to use or manipulate others in order to achieve our own
happiness. In Kant’s eyes, if you falsely promise a lender to repay a loan, you are manipulating
that person’s trust in you for your own ends because she would not agree to the loan if she knew
all the facts.
Modern Rights Theories Strict deontological ethical theories like Kant’s face an obvious
problem: The duties are often viewed as absolute and universally applicable. A deontologist
might argue that one must never lie or kill, even though most of us find lying and killing
acceptable in some contexts, such as in self-defense. Responding to these difficulties, some
modern philosophers have proposed mixed deontological theories. There are many theories here,
but one popular theory requires us to abide by a moral rule unless a more important rule conflicts
with it. In other words, our moral compulsion is not to compromise a person’s right unless a
greater right takes priority over it.
14
For example, members of society have the right not to be lied to. Therefore, in most contexts you
are morally compelled not to tell a falsehood. That is an important right because it is critical in a
community or marketplace that one be able to rely on another’s word. If, however, you could
save someone’s life by telling a falsehood, such as telling a lie to a criminal about where a
witness who will testify against him can be found, you probably will be required to save that
person’s life by lying about his whereabouts. In this context, the witness’s right to live is a more
important right than the criminal’s right to hear the truth. In effect, one right “trumps” the other
right.
What are these fundamental rights? How do we rank them in importance? Seventeenth-century
philosopher John Locke argued for fundamental rights that we see embodied in the constitutions
of modern democratic states: the protection of life, liberty, and property. Libertarians and others
include the important rights of freedom of contract and freedom of expression. Modern liberals,
like Bertolt Brecht, argued that all humans have basic rights to employment, food, housing, and
education. In much of the ongoing debate page 4-6around health care policy in the United States,
a key question is whether or not every citizen has a right to health care.
Strengths of Rights Theory The major strength of rights theory is that it recognizes the moral
worth of each individual and the importance of protecting fundamental rights. This means that
members of modern democratic societies have extensive liberties and rights around which a
consensus has formed and citizens need not fear the removal of these rights by their government
15
or other members of society. In the U.S. context, one need look no further than the Declaration of
Independence and its emphasis on “life, liberty, and the pursuit of happiness” as those
“unalienable rights” that lie beyond the reach of government interference. In the global context,
the Universal Declaration of Human Rights was adopted by the United Nations in 1948 as an
expression of fundamental rights to which many people believe all are entitled.
Criticisms of Rights Theory Most of the criticisms of rights theory deal with the near absolute
yet relative value of the rights protected, sometimes making it difficult to articulate and
administer a comprehensive rights theory. First, it is difficult to achieve agreement about which
rights are protected. Rights fundamental to modern countries like the United States (such as
many women’s or GLBT rights) are more limited in other countries around the world. Even
within one country, citizens disagree on the existence and ranking of rights. For example, as
noted earlier, some Americans argue that the right to health care is an important need that should
be met by government or a person’s employer. Other Americans believe funding universal health
care would interfere with the libertarian right to limited government intervention in our lives.
Balancing rights in conflict can be difficult.
In addition, rights theory does not concern itself with the costs or benefits of requiring respect for
another’s right. For example, rights theory probably justifies the protection of a neo-Nazi’s right
to spout hateful speech, even though the costs of such speech, including damage to relations
between ethnic groups, may far outweigh any benefits the speaker, listeners, and society receive
from the speech.
16
Moreover, in the context of discussions around public policy and political economy, some argue
that rights theory can be perverted to create a sense of entitlement reducing innovation,
entrepreneurship, and production. For example, if one is able to claim an entitlement to a job, a
place to live, food, and health care—regardless of how hard he is expected to work—motivations
to pull one’s own weight and contribute to society and the greater good may be compromised,
resulting in a financially unsustainable culture of dependency. The overlap between theories of
ethics and their political policy implications is explored further as we turn our attention to justice
theory.
The Global Business Environment
Justice Theory In 1971, John Rawls published his book A Theory of Justice, the philosophical
underpinning for the bureaucratic welfare state. Based upon the principle of justice, Rawls
reasoned that it was right for governments to redistribute wealth in order to help the poor and
disadvantaged. He argued for a just distribution of society’s resources by which a society’s
benefits and burdens are allocated fairly among its members.
Rawls expressed this philosophy in his Greatest Equal Liberty Principle: Each person has an
equal right to basic rights and liberties. He qualified or limited this principle with the Difference
Principle: Social inequalities are acceptable only if they cannot be eliminated without making the
worst-off class even worse off. The basic structure is perfectly just, he wrote, when the prospects
of the least fortunate are as great as they can be.
17
Rawls’s justice theory has application in the business context. Justice theory requires decision
makers to be guided by fairness and impartiality and to take seriously what outcomes these
principles produce. In the business context, justice theory prompts leadership to ask: Are our
employees getting what they deserve? It would mean, for example, that a business deciding in
which of two communities to build a new manufacturing plant should consider which
community has the greater need for economic development.
Chief among Rawls’s critics was his Harvard colleague Robert Nozick. Nozick argued that the
rights of the individual are primary and that nothing more was justified than a minimal
government that protected against violence and theft and ensured the enforcement of contracts.
Nozick espoused a libertarian view that unequal distribution of wealth is moral if there is equal
opportunity. Applied to the business context, Nozick’s formulation of justice would permit a
business to choose between two manufacturing plant sites after giving each community the
opportunity to make its best bid for the plant. Instead of picking the community most in need, the
business may pick the one offering the best deal.
Strengths of Justice Theory The strength of Rawls’s justice theory lies in its basic premise that
society owes a duty to protect those who are least advantaged—that is, positioned unfairly vis-àvis the distribution of social goods. Its motives are consistent with the religious and secular
philosophies that urge humans to help those in need. Many religions and cultures hold basic to
their faith the assistance of those who are less fortunate.
18
Criticisms of Justice Theory Rawls’s justice theory shares some of the criticisms of rights theory.
It treats equality as an absolute, without examining the potential costs of producing equality,
including reduced incentives for innovation, entrepreneurship, and production. Moreover, any
attempt to rearrange social benefits requires an accurate measurement of current wealth. For
example, if a business is unable to measure accurately which employees are in greater need of
benefits due to their wealth level, application of justice theory may make the business a Robin
Hood in reverse: taking from the poor to give to the rich.
Utilitarianism Utilitarianism requires a decision maker to maximize utility for society as a whole.
Maximizing utility means achieving the highest level of satisfactions over dissatisfactions. This
means that a person must consider the benefits and costs of his actions to everyone in society.
A utilitarian will act only if the benefits of the action to society outweigh the societal costs of the
action. Note that the focus is on society as a whole. This means a decision maker may be
required to do something that harms her if society as a whole is benefited by her action. A
teleological theory, utilitarianism judges our actions as good or bad depending on their
consequences. This is sometimes expressed as “the ends justify the means.”
Utilitarianism is most identified with 19th-century philosophers Jeremy Bentham and John Stuart
Mill. Bentham argued that maximizing utility meant achieving the greatest overall balance of
19
pleasure over pain. A critic of utilitarianism, Thomas Carlyle, called utilitarianism “pig
philosophy” because it appeared to base the goal of ethics on the swinish pleasures of the
multitude.
Mill thought Bentham’s approach too narrow and broadened the definition of utility to include
satisfactions such as health, knowledge, friendship, and aesthetic delights. Responding to
Carlyle’s criticisms, Mill also wrote that some satisfactions count more than others. For example,
the pleasure of seeing wild animals free in the world may be a greater satisfaction morally than
shooting them and seeing them stuffed in one’s den.
How does utilitarianism work in practice? It requires that you consider not just the impact of
decisions on yourself, your family, and your friends, but also the impact on everyone in society.
Before deciding whether to ride a bicycle page 4-8to school or work rather than to drive a car, a
utilitarian would consider the wear and tear on her clothes, the time saved or lost by riding a
bike, the displeasure of riding in bad weather, her improved physical condition, her feeling of
satisfaction for not using fossil fuels, the cost of buying more food to fuel her body for the bike
trips, the dangers of riding near automobile traffic, and a host of other factors that affect her
satisfaction and dissatisfaction.
But her utilitarian analysis doesn’t stop there. She has to consider her decision’s effect on the rest
of society. Will she interfere with automobile traffic flow and decrease the driving pleasure of
automobile drivers? Will commuters be encouraged to ride as she does and benefit from doing
20
so? Will her lower use of gasoline for her car reduce demand and consumption of fossil fuels,
saving money for car drivers and reducing pollution? Will her and other bike riders’ increased
food consumption drive up food prices and make it less affordable for poor families? This only
scratches the surface of her utilitarian analysis.
The process we used earlier, act utilitarianism, judges each act separately, assessing a single act’s
benefits and costs to society’s members. Obviously, a person cannot make an act utilitarian
analysis for every decision. It would take too much time and many variables are difficult to
calculate.
Utilitarianism recognizes that human limitation. Rule utilitarianism judges actions by a rule that
over the long run maximizes benefits over costs. For example, you may find that taking a shower
every morning before school or work maximizes society’s satisfactions, as a rule. Most days,
people around you will be benefited by not having to smell noisome odors, and your personal
and professional prospects will improve by practicing good hygiene. Therefore, you are likely to
be a rule utilitarian and shower each morning, even though some days you may not contact other
people.
Many of the habits we have are the result of rule utilitarian analysis. Likewise, many business
practices, such as a retailer’s regular starting and closing times, also are based in rule
utilitarianism.
21
Strengths of Utilitarianism What are the strengths of utilitarianism as a guide for ethical conduct?
It is easy to articulate the standard of conduct: You merely need to do what is best for society as a
whole. Moreover, many find it intuitive to employ an ethical reasoning that seeks to maximize
human flourishing and eliminate harm or suffering.
Criticisms of Utilitarianism Those strengths also expose some of the criticisms of utilitarianism
as an ethical construct. It is difficult to measure one’s own pleasures and pains and satisfactions
and dissatisfactions, let alone those of all of society’s members. In short, how does one
adequately and accurately measure human flourishing? In addition, those benefits and costs are
inevitably distributed unequally across society’s members. It can foster a tyranny of the majority
that may result in morally monstrous behavior, such as a decision by a 100,000-person
community to use a lake as a dump for human waste because only one person otherwise uses or
draws drinking water from the lake.
That example exhibits how utilitarianism differs from rights theory. While rights theory may
protect a person’s right to clean drinking water regardless of its cost, utilitarianism considers the
benefits and costs of that right as only one factor in the total mix of society’s benefits and costs.
In some cases, the cost of interfering with someone’s right may outweigh the benefits to society,
resulting in the same decision that rights theory produces. But where rights theory is essentially a
one-factor analysis, utilitarianism requires a consideration of that factor and a host of others as
well, in an attempt to balance pleasure over pain.
22
A final criticism of utilitarianism is that it is not constrained by law. Certainly, the law is a factor
in utilitarian analysis. Utilitarian analysis must consider, for example, the dissatisfactions
fostered by not complying with the law and by creating an environment of lawlessness in a
society. Yet the law is only one factor in utilitarian analysis. The pains caused by violating the
law may be offset by benefits the violation produces. Rational actors may ultimately determine
that the cost” benefit analysis justifies deviation from a law or rule. Most people, however, are
rule utilitarian when it comes to law, deciding that obeying the law in the long run maximizes
social utility.
Shareholder Theory Premised on the concept that corporate leaders are agents who owe
contractual obligations to investors, shareholder theory argues that ethical dilemmas should be
resolved with a focus on maximizing the firm’s long-term profits within the limits of the law. It is
based in the laissez faire theory of capitalism first expressed by Adam Smith in the 18th century
and more recently promoted by the Nobel Prize” winning economist Milton Friedman. Laissez
faire economists argue total social welfare is optimized if humans are permitted to work toward
their own selfish goals. The role of government, law, and regulation is solely to ensure the
workings of a free market by not interfering with economic liberty, by eliminating collusion
among competitors, and by promoting accurate information in the marketplace.
By focusing on results—maximizing total social welfare through a corporate focus on profit
maximization—a shareholder theory approach to ethical decisions is a page 4-9teleological- or
consequences-oriented ethical theory. It is closely related to utilitarianism, but it differs
23
fundamentally in how ethical decisions are made. While utilitarianism considers all stakeholders
as it seeks to maximize social utility by focusing the actor on a broad-based creation of social
value and reduction in social harm, a shareholder approach to profit maximization optimizes total
social utility by narrowing the actor’s focus, requiring the decision maker to make a wealthmaximizing decision that is focused on enhancing profits for those investors or shareholders who
can claim a direct financial interest in the organization’s bottom line.
Strengths of Focusing on Profit Maximization By working in our own interests, we compete for
society’s scarce resources (iron ore, labor, and land, to name a few), which are allocated to those
people and businesses that can use them most productively. By allocating society’s resources to
their most efficient uses, as determined by a free market, shareholder theory claims to maximize
total social utility or benefits. Thus, in theory, society as a whole is bettered if all of us compete
freely for its resources by trying to increase our personal or organizational profits. If we fail to
maximize profits, some of society’s resources will be allocated to less productive uses that
reduce society’s total welfare.
In addition, shareholder theory emphasizes that a commitment first and foremost to profit
maximization must always be constrained by what is permitted under the law. A profit maximizer
theoretically acts ethically by complying with society’s mores as expressed in its laws.
Moreover, the emphasis on profit maximization requires the decision maker and business to be
disciplined according to the dictates of the marketplace. Consequently, an analysis of the ethical
24
issue pursuant to shareholder theory probably requires a decision maker to consider the rights
protected by rights theory, especially the shareholder’s or investor’s contractual rights to a return
on investment, as well as fairness dictates embedded in justice theory. Ignoring important rights
of employees, customers, suppliers, communities, and other stakeholders may negatively impact
a corporation’s long-term profits. A business that engages in behavior that is judged unethical by
consumers and other members of society is subject to boycotts, adverse publicity, demands for
more restrictive laws, and other reactions that damage its image, decrease its revenue, and
increase its costs.
Consider, for example, the reduced sales of Martha Stewart” branded goods at Kmart after Ms.
Stewart was accused of trading ImClone stock while possessing inside information. Consider
also the fewer number of college graduates willing to work for Waste Management Inc. in the
wake of adverse publicity and indictments against its executives for misstating its financial
results. Note also the higher cost of capital for firms like Dell as investors bid down the stock
price of companies accused of accounting irregularities and other wrongdoing.
All these reactions to perceived unethical conduct impact the business’s profitability in the short
and long run, motivating that business to make decisions that comply with ethical views that
transcend legal requirements.
Criticisms of Focusing on Profit Maximization The strengths of shareholder theory’s emphasis
on profit maximization as a model for ethical behavior also suggest criticisms and weaknesses of
25
the theory. Striking at the heart of the theory is the criticism that corporate managers are subject
to human failings that make it impossible for them to maximize corporate profits. The failure to
discover and process all relevant information and varying levels of aversion to risk can result in
one manager making a different decision than another manager. Group decision making in the
business context introduces other dynamics that interfere with rational decision making. Social
psychologists have found that groups often accept a higher level of risk than they would as
individuals. There is also the tendency of a group to internalize the group’s values and suppress
critical thought.
Furthermore, even if an emphasis on profit maximization results in an efficient allocation of
society’s resources and maximization of total social welfare, it does not concern itself with how
wealth is allocated within society. In the United States, the top wealthiest 1 percent own more
than 40 percent of the nation’s wealth, and globally, it is estimated that 26 individuals control
more wealth than the combined wealth of 50 percent of the global population. To some people,
those levels of wealth disparity are unacceptable. To laissez faire economists, wealth disparity is
an inevitable component of a free market that rewards hard work, acquired skills, innovation, and
risk taking. Yet critics of shareholder theory’s emphasis on profit maximization respond that
market imperfections, structural barriers, and a person’s position in life at birth interfere with his
ability to compete.
Critics charge that the ability of laws and market forces to control corporate behavior is limited
because it requires lawmakers, consumers, employees, and other constituents to detect unethical
26
corporate acts and take appropriate steps. Even if consumers notice irresponsible behavior and
inform a corporation, a bureaucratic corporate structure may interfere with the information being
received by the proper person inside the corporation. If, instead, page 4-10consumers are silent
and refuse to buy corporate products because of perceived unethical acts, corporate management
may notice a decrease in sales, yet attribute it to something other than the corporation’s unethical
behavior.
Critics also argue that equating ethical behavior with legal compliance is a tautology in countries
like the United States where businesses distort the lawmaking process by lobbying legislators
and making political contributions. It cannot be ethical, they argue, for businesses to merely
comply with laws reflecting the interests of businesses and over which corporations have
enormous influence post” Citizens United.
Proponents of the emphasis on profit maximization respond that many laws restraining
businesses are passed despite businesses lobbying against those laws. The Sarbanes” Oxley Act,
which increases penalties for wrongdoing executives, requires CEOs to certify financial
statements, and imposes internal governance rules on public companies, is such an example. So
are laws restricting drug companies from selling a drug unless it is approved by the Food and
Drug Administration and requiring environmental impact studies before a business may construct
a new manufacturing plant. Moreover, businesses are nothing other than a collection of
individual stakeholders, which includes employees, shareholders, and their communities. When
27
they act to influence political policies or lobby for legal or regulatory change, their advocacy is
arguably in the best interests of all these stakeholders.
Critics respond that ethics transcends law, requiring, in some situations, that businesses adhere to
a higher standard than required by law. We understand this in our personal lives. For example,
despite the absence of law dictating, for the most part, how we treat friends, we know that ethical
behavior requires us to be loyal to friends and to spend time with them when they need our help.
In the business context, a firm may be permitted to release employees for nearly any reason,
except the few legally banned bases of discrimination (such as race, age, and gender), yet some
critics will argue businesses should not terminate an employee for other reasons currently not
banned by most laws (such as sexual orientation or appearance). Moreover, these critics further
argue that businesses—due to their influential role in a modern society—should be leaders in
setting a standard for ethical conduct.
Those who emphasize profit maximization respond that such an ethical standard is difficult to
define and hampers efficient decision making. Moreover, they argue that experience shows the
law has been a particularly relevant definition of ethical conduct. Consider that many corporate
scandals would have been prevented had the executives merely complied with the law and had
existing regulations been enforced. For example, Enron executives illegally kept some liabilities
off the firm’s financial statements, while regulatory oversight also failed. Tyco and Adelphia
executives illegally looted corporate assets. Had these executives page 4-11simply complied with
28
the law and maximized their firms’ long-run profits, none of those ethical debacles would have
occurred.

Purchase answer to see full
attachment

SDSU Business Law Environmental Regulations and Ethics Discussion