LS311 – Business Law ILS311 – Business Law I

Seminar Presentation

UNIT 9Business Organizations

Chapter 26: Corporate Directors, Officer, & Shareholders

Chapter 27: Investor Protection, Insider Trading, & Corporate Governance

Unit 9 Unit 9

• Three (3) items to complete in Unit 9. They are: – Unit 9 Written Assignment (40 points)– Unit 9 DB (20 points) – Unit 9 Case Study (20 points)

• Let’s discuss Chapter 26

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Chapter 26: Chapter 26: Role of Directors & OfficersRole of Directors & Officers

• Every corporation is governed by a board of directors.

• Individual directors are not agents of corporation, only the board itself can act as a “super-agent” and bind the corporation.

• A director can also be a shareholder, especially in closely-held corporations.

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Election and Compensation Election and Compensation of Directorsof Directors

• The number of directors is set forth in the articles of incorporation:– Directors are appointed at the first organizational

meeting– In closely held companies, directors are generally

the incorporators and/or the shareholders– Term of office is generally for one year– Director can be removed for cause

• In very large companies, directors can be compensated, and may be officers as well.

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Board of Directors’ MeetingsBoard of Directors’ Meetings

• Directors hold meetings pursuant to bylaws with recorded minutes

• Special meetings may be called with sufficient notice

• Meetings require QUORUM (minimum number of directors to conduct official corporate business, usually majority)

• Each director generally has one vote

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Rights of DirectorsRights of Directors

Directors have the right to:• Participate in corporate decisions and inspect

corporate books and records• Compensation (usually a nominal sum) and

indemnification. If a director is sued for acts as director, the corporation should guarantee reimbursement (indemnification) or purchase liability insurance to protect the board from personal liability

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• Officers serve at the pleasure of the Board of Directors but have fiduciary duties to company as well

• Their employment relationships are generally governed by contract law and employment law

• Officers may be terminated for cause

Corporate Officers and Corporate Officers and ExecutivesExecutives

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• Fiduciaries of corporation - ethical & legal duties

• Duty of Care – Act in good faith and in best interests of the corp.;

– Make informed and reasonable decisions; and

– Exercise reasonable supervision

• Duty of Loyalty– No conflict of interest

– No insider trading

• A dissenting director is rarely held liable

Duties and Liabilities of Duties and Liabilities of Directors and OfficersDirectors and Officers

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Business Judgment RuleBusiness Judgment Rule

• Immunizes a director or officer from liability from consequences of a business decision that turned sour

• Court will not require directors or officers to manage “in hindsight”

• As long as decision was reasonable, informed, made in good faith and in the best interests of the corporation, BJR will apply

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Role of ShareholdersRole of Shareholders

• Ownership of shares grants a shareholder an equitable ownership interest in a corporation.

• Shareholders generally have no right to manage the daily affairs of the corporation, but do so indirectly by electing directors.

• Shareholders are generally protected from personally liability by the corporate veil of limited liability.

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• Common shareholder - one vote per share

• Articles and bylaws can exclude or limit voting rights of certain classes of stock

• Quorum must be present

• Cumulative Voting allows minority shareholders to get a board member elected

Shareholder VotingShareholder Voting

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• To vote• To have a stock certificate• To purchase newly issued stock• To dividends, when declared by board• To inspect corporate records• To transfer shares, with some exceptions• To a proportionate share of corporate assets on

dissolution• To file suit on behalf of corporation

Rights of ShareholdersRights of Shareholders

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• Shareholders can sue a 3rd party on behalf of the corporation if the Directors fail or refuse to correct the wrong or injury.

• Directors may refuse to take action because they might personally be liable.

• Any damages recovered go to corporation’s treasury.

Shareholder’s Derivative SuitShareholder’s Derivative Suit

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• Shareholders are generally not liable for the contracts or torts of the corporation.

• If the corporation fails, shareholders cannot lose more than their investment, except when: – A shareholder hasn’t paid for stock pursuant to the

stock subscription agreement.– Shareholder buys “watered stock” which is below

the stock’s par value.

Liabilities of ShareholdersLiabilities of Shareholders

Chapter 27:Chapter 27:The Securities ActsThe Securities Acts

• In response to the stock market crash of 1929 and the Great Depression, Congress enacted two acts:– Securities Act of 1933– Securities Exchange Act of 1934

• Apply to public companies

• To structure and oversee the offering, selling, and trading of securities in ways that would protect investors

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Securities Act of 1933Securities Act of 1933

• Requires that investors receive information about securities offered for public sale

• Prohibits fraud in the sale of securities by requiring that securities be registered

• Registration includes information including– a description of properties and business,

– a description of the security to be offered for sale,

– information about management of the company, &

– financial statements certified by independent accountants

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Registration ProcessRegistration Process

• Registration statement does not become effective until approval by SEC.

• Pre-Filing Period: issuer cannot offer or sell securities.

• Waiting Period: securities can be offered by not sold. 2005: Free-writing prospectus.

• Post-Effective Period: registration effective 20 days after approval.

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Violations of the 1933 ActViolations of the 1933 Act

• Intentional or negligent fraud of investors by misrepresenting or omitting material facts in the registration statement and/prospectus.

• Defenses: Statement left out was not material; Plaintiff knew about fraud and purchased stock; Registrant believed statements were true.

• Penalties:

– Criminal: up to 5 years in prison and $10,000 fine.

– Civil: damages, refund of investment, injunction.

Securities Exchange Act of 1934 Securities Exchange Act of 1934

• Created the Securities and Exchange Commission (SEC)

• Power to register, regulate, and oversee brokerage firms, transfer agents, clearing agencies, and securities self-regulatory organizations

• To give the investor confidence and prevent another collapse in the system

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Section 10(b) and Rule 10b(5) Section 10(b) and Rule 10b(5)

• Section 10(b) prohibits the use of any manipulative or deceptive device or contrivance in contravention of rules and regulations of SEC.

• Rule 10b(5) prohibits the commission of fraud in the connection with the purchase or sale of any security.

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• Advance information available to corporate officers and directors that can affect future value of stock.

• Insider information must be material

• Must be a fiduciary relationship for liability

Insider TradingInsider Trading

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Insider Reporting and Insider Reporting and Trading—Section 16(b)Trading—Section 16(b)

• Section 16(b)– Recapture by corporation of profits during

previous six months gained by insider trading.– Applies to stocks, warrants, options and

convertible securities.

• Proxy Statements, Section 14(a)– Whoever solicits a proxy must fully disclose all of

the facts and which shareholders must vote.

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Comparison of 10b-5 and 16(b)Comparison of 10b-5 and 16(b)

Sarbanes-Oxley Act of 2002Sarbanes-Oxley Act of 2002

• In response to the Enron fall in 2001, Congress enacted the Sarbanes-Oxley Act of 2002 (SOX).– To protect investors by improving the accuracy

and reliability of corporate disclosures,– To enhance corporate responsibility, – To end corporate and accounting fraud, and– To restore the image of stock purchases as

investments worth the risk.

• Requires documented internal controls

• Requires CEO and CFO certifications25

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Key Provisions: Sarb-OxKey Provisions: Sarb-Ox

Unit 9 Written Assignment Unit 9 Written Assignment Chapter 27 Chapter 27

• Case Scenario: Dale Emerson served as the chief financial officer for Reliant Electric Company, a distributor of electricity serving portions of Montana and North Dakota. Reliant was in the final stages of planning a takeover of Dakota Gasworks, Inc. a natural gas distributor that operated solely within North Dakota. Emerson went on a weekend fishing trip with his uncle, Ernest Wallace.

• Emerson mentioned to Wallace that he had been putting in a lot of extra hours at the office planning a takeover of Dakota Gasworks. On returning from the fishing trip, Wallace met with a broker from Chambers Investments and purchased $20,000 of Reliant stock. Three weeks later, Reliant made a tender offer to Dakota Gasworks stockholders and purchased 57% of Dakota Gasworks stock. Over the next two weeks, the price of Reliant stock rose 72% before leveling out. Wallace then sold his Reliant stock for a gross profit of $14,400.

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Unit 9 Written AssignmentUnit 9 Written AssignmentChapter 27 Chapter 27

• For your Assignment answer the following questions:

1. Would registration with the SEC be required for Dakota Gasworks securities?

2. Did Emerson violate Section 10(b) of the Securities Exchange Act of 1934 and SEC Rule 10b-5?

3. What theory or theories might a court use to hold Wallace liable for insider trading?

4. Under the Sarbanes-Oxley Act of 2002, who would be required to certify the accuracy of financial statements filed with the SEC?

• Note: Your assignment must be in APA format, include a title page, the paper itself (the discussion) and a reference page

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Questions & RemindersQuestions & Reminders

• Questions on Unit 9 material?

• Remember to complete all Assignments

– Unit Self-Check Quiz (Not for a grade)

– Discussion (See Discussion Board Posting Requirements)

– Written Assignment

– Case Analysis

• Office Hours: Thursdays 7-9PM (ET)

• Have a great week!

• Good luck on the final!

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