Read "Theory to Practice" at the end of in Chapter 16 regarding "Cool Runnings Manufacturing Company". Answer all of the questions provided with support for full credit.

THEORY TO PRACTICE Four individuals are the collective owners, directors, and shareholders (\"principals\") of Cool Runnings Manufacturing Company (CRMC), which designs and manufactures snow sports equipment such as snow- boards, racing skis, and related products. The prin- cipals built the company over a 10-year period from start-up to over $20 million in annual revenue. Six months ago, the principals met and decided to embark on an aggressive expansion plan with the objective of doubling CRMC''s production capacity in five years. This plan required approximately $50 million to fund the purchase of real estate, equipment, expanded payroll, additional taxes, and marketing expenses. One reason for this expansion plan was to develop a new snowboard product, the Tectonic Board, which early marketing research indicated would become one of CRMC''s best-selling products. The princi- pals were under pressure to develop this new product because of an overall slump in sales. However, given CRMC's current facilities and budget, the product CHAPTER SIXTEEN | Regulation of Securities, Corporate Governance, and Financial Markets 561 with the investors, the CEO makes the following state- was currently only halfway through the design phase and not expected to be on the market for at least ments in response to investor questions: three more years. The demand for CRMC's existing brands of snowboards was slowly, but steadily, declin Question: Is CRMC's financial position currently ing. In fact, the company's profits had been so stag- sound, or are there threats to your financial nant that it could not reasonably afford to borrow the well-being? entire amount of the expansion cost given its recently CEO. CRMC's cash flow is expected to increase diminishing cash flow. However, because of the devel- steadily because the Tectonic Board is the opment of the Tectonic Board, the principals are hope- board for a new generation of boarders. Our ful that they can attract capital by selling stock to research shows that it has potential to bring investors. us a sizable return on our investment. 1. What are the alternatives for financing this expan- Question: What stage of development is the Tectonic sion plan? Should CRMC consider a bond? Why Board in? or why not? Would selling equity be more or less advantageous than issuing a bond? CEO: If all goes well, it will be on store shelves in less than one year. 2. Assume that the principals decide to issue stock to the public in order to raise money. They know of Question: Is there a current demand for your existing five investors that may be interested in this opportun snowboard products? nity, so they send each a copy of the business plan CEO: We have had very strong sales. However, like for CRMC's expansion along with a cover letter every product, they have their ups and downs. explaining the price of the stock and giving instruc- They're likely to be on the upside shortly. tions on how to buy the stock. Has CRMC commit- ted a violation of securities laws by sending out the business plan and cover letter? Could that constitute 4. Based on the CEO's statements, one investor pur- the sale of a security? chases a substantial amount of stock. If the business venture fails before the Tectonic Board is released, 3. Suppose that, instead of sending the business plan (as in Question 2 above), the principals consult counsel will the investor have any recourse against CRMC and inform her that they wish to develop a prospectus and its CEO based on the statements made by the CEO? Why or why not? and distribute it to a limited number of high-net-worth investors. Must the securities be registered before 5. If an investor files a fraud suit against CRMC and marketing or selling them? If not, what exemption(s) its CEO, will his statements alone be sufficient to could they fall into? pass the PSLRA standards for scienter? Assume that the principals proceed as in Question 3 6. Do any of the statements themselves constitute the and send the plan to 15 high-net-worth potential inves- required elements under PSLRA? What type of con- tors. During face-to-face and videoconference meetings duct, if coupled with the statements, could meet the scienter standard