Business Organizations Fall 2010 Outline for Final Exam

8/8/2019 Business Organizations Fall 2010 Outline for Final Exam

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Business Organizations Fall 2010 Outline for Final Exam

I. PUBLIC OFFERINGS (SEA of 1933)A. Securities Act of 1933 FILING REQUIREMENTS: General

Provisions

i. Must file registration statement prior to solicitation (Sect.5)ii. Violation to make misrepresentation or omission in the

offering statement (includes fraud) Section. 12, 17[imposes liability on the issuer in factor of the purchaserfor consideration paid less any income received].

iii. Issuer must disclose the consideration to be paid in anyoffering.

iv. Section 5 applies on to issuers, underwriters, or dealersinvolved in a public offering.

1. Requires full disclosure in offering documents.2. Relates to purchase & sale of securities throughinterstate commerce of mails via offering or

solicitation. Applies only to initial offerings.3. Not applicable if fall within the exemptions under

Regulation D or Intrastate exemptions & nosolicitation, file notice with the SEC, & transactioninvolves offers solely to one or more accreditedinvestors.

B. REGULATION D EXEPTIONS: limits in the amount being raised &number of investors involved.

i. Not subject to SEA but still subject to state blue sky laws.ii. Regulation D is a private offering safe harbor exemption to

the registration requirement under Section 5 of theSecurities Act of 1933 (SA). & although an issuer thatsatisfies one or more of the exemptions provided byRegulation D, the issuer remains subject to all of the anti-fraud provisions of other federal & state securities (bluesky) laws. As a result, the following is a very simplifiedoverview of certain of the applicable exemptions.

iii. Regulation D was adopted by the commission in 1982 as asafe harbor for private placements. It provides an issuerof securities three possible exemptions from the

registration requirement.iv. Exemptions provided under Regulation D are:

1. 504: offerings of up to $1M in any 12 month period2. 505: offerings of up to $5 M in any 12 month period

up to 35 investors3. 506: offerings with no $ limitation but solicitation to

up to 35 sophisticated investors [different from


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accredited investor has a minimum net worth of $1M or makes $200K per year] (Factual determination)

v. Issuer must examine which one or more of the threeexemptions provided by Regulation D can be utilized forthe planned offering & sale of the issuers securities.

1. Section (502) provides the factors to considerdetermining if two or more offerings will beintegrated & considered one offering.

2. (501(A)) Private offerings to Accredited Investors:Banks, savings & loan, directors or officers of theissuing company, & persons with a net worth thatexceeds $1M or an individual with an individualincome of $200K for the last 2 years, or a joint incomeof $300K. Specifically excluded from being counted inany offering conducted under a claim of exemptionpursuant to 504-506 of Regulation D.

3. (Rule 504)Offerings of less than $1M during any 12month period & where the issuer need not complywith any disclosure requirements.

4. (Rule 505)Offerings to up to 35 persons & the totaloffering does not exceed $5M in any 12 month Period,provided that no officer, director, affiliate, or agent ofthe issuer is a bad boy within the meaning of Rule262 of Regulation A.

5. (Rule 506) Offerings to up to 35 Investors with nodollar limit so long as all of the investors aresophisticated, i.e. knowledge & experience capable of

evaluating the merits & risks. Per 501a. Burden of proof is on the issuer.b. All securities sold in offerings under 505,506,

must contain restricted securities legendrestricting their resale.

c. Securities sold in 504 offering may be issuedwithout a restricted securities legendprovided that certain state registrationrequirements are met.

i. If the offer fails to meet the aboveexemptions, it may still meet

requirements of statutory Section 4(2)exemption, used in venture capitaltransactions & as a residual claim ofexemption where an issuer hasotherwise failed to fully comply withone or more other exemptions.

ii. NOTE: total offering limitation will beaffected by whether the transactions


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are construed as part of the sameintegrated plan or differenttransactions.

C. STEPS IN EXAMINING IF A TRANSACTION IS EXEMPT FROMREGISTRATION:

i. Is it a private offering under SA section 4(2)?1. Use of interstate commerce, number & type of theproposed investors, & total $$ amount of the offering.(if not, then the issuer may be found to have violatedSection 5 & thereby section 12.)

ii. Is transaction exempt under a federal exemption?1. Issuer bears the burden of pleading & proving that

the offering met the requirements of at least oneexemption. Many offerings can be conducted undermore than one claim of exemption.

iii. Are there two or more offerings in any 12-month period?1. Can offerings be deemed to be one offering?2. Reg. D has specific aggregation rules for 504&505

offerings.3. Where offerings are aggregated, the issuer may lose

the claim of exemption for the second offering if the $limits or head count limitations exceed those allowed.

iv. Offerings conducted within a 6-month period may beaggregated.

1. If amounts are not allowed under the applicableexemption, the issuer could lose the claim ofexemption.

v. Meet applicable provisions of each state blue sky law?vi. Issuers offering & sale of securities may still be

successfully attacked if it violated the anti fraudprovisions of federal & state securities laws.

D. Publicly-Traded Company (Minimum assets of $5M)i. Overview

1. Shares traded to the public2. Shareholders play a nominal role3. Only recourse is to sell shares4. Not involved in the management5. Most shareholders own less than 10% of the stock6. Officers & directors run the company7. Board of directors is elected

a. Inside directors: Shareholder & directorb. Outside directors: Not involved with the

company except for with the boardc. Affiliated directors: Some financial interest


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ii. Three Basic Points1. Major differences between close Corp or C corps & public

corporations relate to the size, revenues, secondarymarket for the shares, & the respective roles of directors

& officers over shareholders, who play a nominal role.2. The SEC provides greater oversight of public

corporations. The registration requirements for taking acompany public are governed by the SEA of 1933 is toprovide potential investors (who are not insiders) withfull & detailed disclosure of information.

3. Exemptions apply based upon the qualifications of theinvestors, the amount of the offering, or the residence ofthe persons to whom the offering is made.

a. Exemption: Cost of regulatory compliance is lessbecause you are exempt from regulatory

requirementsb. Offering stock a small number of investors

(dealing with accredited investors).iii. SEA 1934 Proxy regulation & Inside-Trading

1. Attempt to obtain the right & vote proxy2. Only way business is done in a publicly held corporation

is through proxies3. Cannot make any material omissions or material

misrepresentations of face in any proxy solicitationmaterial

4. Cannot make any material misstatements ormisrepresentations related to the purchase or sale ofstock.

iv. Williams ActImposes strict liability when involved intender offer (Offer to acquire someone elses shares to takecontrol)

1. If you have knowledge of material facts related to atender offer, you cannot disclose those facts until theybecome public knowledge.

2. Make sure no one takes undue advantage to buy orsell stock (insider trading).

v. Public Corporations must comply with both federal securitiesregulation & state blue sky laws.

1. State version of the rules studied at the federal level2. Understand self-dealing, proxy regulation, & fraud are

pursued at state level3. Can pursue state & federal action at the same time, same

transactions, & get remedies for both in same state4. Federal statute makes it easier to get remedy.5. Prima facie case is different at the state & federal levels


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E. Definitionsi. Underwriter:Any person who has purchased shares with a

view toward further distribution.

1. Musthave something of universal interest2. Not a lot of companies3. Determine which companies have that universal interest4. Get 7% of whatever amount is acquired.

ii. Issuer: Corporation whose shares are being offered or anyperson controlled by the corporation or acting on its behalf.

1. Goes to underwriter to get the funds2. They put up the cash3. Usually multiple parties (Banks etc)4. Take Stock & resell an open market for higher price.

iii. Dealer: Person who acts as an agent, broker, or principal partor full time in the business of offering, buying selling, ordealing in securities issued by another.

1. Has a series of clients, collects the money from the clients2. Fee for brokering (Charles Schwab, Merrill Lynch, etc)

iv. Accredited Investors: Banks, Insurance Companies, InvestmentCompanies, BusinessDevelopment Companies, EmployeeBenefitPlans are usually subject to statutory requirements.

1. Institutions that are involved in the process2. Deemed to have sufficient knowledge & expertise to take

care of themselves in the security Market.3. SEC is not worried about accredited investors.

F. Types ofSecuritiesi. Private Equity Private investors who invest while it is private

to ride until it goes publicii. Public Markets Publicly-held Companies

iii. Small (300M) Mid (2B) Larger (2-10B) Cap Stocks Tied tocapitalization requirements

iv. Fixed Income Treasury shares (redeemed & reissued) &Bonds

v. Hedge Funds/Exotic IssuesG. Critical Terms

i. Capitalization Amount Received from selling securitiesii. Valuation Projected CashFlow

iii. Earnings Net CashFlowiv. Assets Tangible & intangible personal & real property (book,

resale or liquidation value)v. Minimum market capitalization cash flow x valuation factor =

future income stream


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vi. Valuation Factor income potential discounted in presentvalue by the risk; varies depending upon perceived value ofassets & future income potential.

H. Valuation Examplesi. Underwriter sets the valuation of the company. There are

several methods for computing including a capitalization ratetied to cash flow, or some growth factor.

ii. Under the cash flow valuation, assume thatAB software islikely to have a consistent permanent stream of cash flow. Thepresent value of the stream is equal to the reciprocal of theinterest rate multiplied by the payment: Present value =Payment X1/discount rate (TABLE BELOW)

iii. RULE OF THUMB: The higher the risk, the higher the discountrate, the smaller the multiplier & the lower the value placed oncash flow. As a practical reality, it is hard to determine areliable discount rate.


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II. MANAGEMENT & DUTIESDuty Obligation Violation

Care Reasonable Investigation;Reliance; & HonestError

Negligence, Imprudence,Waste, Recklessness,Insider-Trading

Loyalty Full & completedisclosures; Covenant notto compete

Self-dealing;UsurpingCorporate Opportunity;Interested Transaction;Insider-Trading

Good Faith Absence of ill intent;Reasonable care; Prudence

Bad faith; Fraud; Insider-Trading

A. DIRECTORS DUTY OF CARE: absence of negligencei. Duty: General Duty of care & loyalty to refrain from

negligence or imprudence.1. Exception: Reasonable business judgment if the

director acts in good faith & commits honest error,taking prudent steps to be informed.

2. Focus on process.3. Requires investigation of facts & informed decision

by relying on experts in order to be insulated fromliability.

4. has the duty to show that there is a duty of care tobe exercised & that the duty of care was breached, the

burden shifts to the to show that it was in the bestinterest of the corporation

ii. Liability: Director is personally liable for direct &proximate losses suffered by corporation & extends to alldirectors who have knowledge of, participate, acquiesce orratify the action.

1. BJR will not insulate self dealing2. A director is liable if it is an illegal action, despite

good faith or if negligent (should know & dont)3. Not liable if they have exercised reasonable judgment

& there is full disclosure of all material facts.iii. Defenses:

1. Reliance on expert advice, or excused or non-habitualabsence from meeting.

a. Expert does not have to be outside the corp.b. Defense against negligence, breach of duty of

care


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2. Age, experience, industry are considered to establishreasonable standard.

3. Unanimous shareholder ratification if there is fulldisclosure of all material facts & the disinterestedshareholders ratify the action

a. Personal interest/self dealing will not allowthe business judgment rule to applyb. Use intrinsic fairness test when there is self-

dealing.B. DIRECTORS DUTY OF GOOD FAITH: Must establish bad faith (may

be deemed a subset of duty of care/loyalty in the absence offraud).

i. Usually discussed in tandem with other dutiesii. You have the best interest of the corporation at heart

1. What is behind your actions2. Focus is on intention

iii. If you have exercised reasonable judgment, duty of care,not involved in the transaction, then generally good faithis presumed.

1. Bad faith Requires fraud2. Unless there is fraud, good faith will be discussed

with one of the other two duties.C. DIRECTORS DUTY OF LOYALTY: Conflict of interest, self-dealing,

etc.i. Taking advantage of transaction or receiving benefit

without approval from disinterest party self dealing,usurping the corporate opportunity

ii. Conflict of Interest OR unauthorized interestedtransaction

1. Voidable transaction not automatically invalid2. Whether there is injury to corporation & whether it is

fair3. MUST HAVE DISINTERESTED COMMITTEE RATIFY TO

USE BJR.iii. Interested Directors: Director is liable to corporation if

there exists a conflict of interest or personal interest, &transaction is not authorized, disclosed or fair.

1. If a majority of directors are interested, shareholdersmay authorize action.

2. Interested directors are not counted in quorum orvote unless the bylaws state to the contrary MUSTBE IN BYLAWS

a. Interested parties CANNOT PARTICIPATE INDELIBERATION OR VOTE

b. They can provide facts only3. Remedies


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a. Void K if no disclosureb. Recover damage for unfair profit

D. BUSINESS JUDGMENT RULE:i. Insulates directors from liability for their business

decisions.

1. Does not apply to interested or self-dealingtransactions unless disinterested directors given full& complete disclosure make that decision.

2. If all directors are interested, then board can appointa committee or go to shareholders.

a. Disinterest is presumed by directors eventhough they may incur liability as directors,may be related or affiliated with the decisionmaker, own stock or have a financial interestin the corp. There must be a personal stake inthe particular transaction.

ii. Arises in 4 situations:1. Exercising reasonable care in performance of duty ofcare, loyalty & good faith.

a. Includes reasonable reliance on experts suchas lawyers, accountants, & honest error.

b. Full disclosure to investigation is required.2. To approve or ratify the transaction after the fact.3. Whether to pursue a derivative action against a

director for actions or inactions that may be harmfulto the corporation.

a. Directors must be disinterested & given full &complete disclosure. If all directors areinterested, then can appoint a committee orgo to shareholders.

4. Whether to dismiss a derivative action brought by ashareholder without demand ( on the basis thatdemand is futile).

E. DIRECT V. DERIVATIVE ACTIONSi. Direct Action: Brought by Shareholder v. Corporation or

purchaser or seller. Remedy goes to the individual.ii. Derivative Action: Brought by Director or Shareholder on

behalf of a Corporation v. a Director or Board for breach of

duty.1. Requirements

a. Shareholder must have been a shareholder atthe time of the violation

b. Shareholder must be a shareholder when thesuit if brought

c. Corporation is named as a defendantd. Remedy goes to the corporation


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2. To bring a derivative action, a shareholder must firstmake a demand of the board of directors, who mustinvestigate & make a reasonable decision to consentor refuse.

a. THIS CLASS: Universal Dem& Requirement must make a demand to the board & wait 90days to allow the board to investigate.

b. If all directors are interest then demand maybe excused & a suit filed, or a disinterestedcommittee appointed to investigate.

c. The decision to bring or not to bring actionwill be protected by the BJR so long as theboard is disinterested.

3. If the board decides not to go forward, they issue awritten report refusing:

a. If the decision is made by a disinterestedgroup of directors the shareholder cannotproceed forward.

b. Decision is protected by the BJR.c. If the Board is interested then the

shareholder can file the action claiming thedecision not to allow the suit to go forwardwas interested.

d. The court will look at the decision & rulewhether it was proper.

4. Must state particular facts in the complaint whatindicate why the board cannot make an impartial

decision/why they are interested & why you couldseek a demand

5. Direct Action remedy goes to individual (no demandrequired for direct action).

F. CORPORATE OPPORTUNITY DOCTRINEi. Director cant take any opportunity that should be offered

first to corporation if the:1. Opportunity is discovered while working for the

corporation (cant compete, take employees ordivulge corporate information);

2. Opportunity is in the same or competing business;or

3. Corporation has an interest in opportunity.a. Challenging party has the burden of proof,

but director must show rejection & that thetaking was fair.

b. Good faith but defective disclosure may becured by ratification following disclosure by


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1. Disclosure to the corporation.2. Corporation cant afford to take advantage & the

director got the opportunity on same terms.3. Opportunity beyond scope of Corporate powers

(ultra vires)

4. No logical relation to business5. No fraud or breach of fiduciary duty (full disclosure)+ not Corp. Opp.

6. Corp. Opp. but no breach of duty of loyalty, goodfaith & fair dealing, officer not liable.

G. SELF-DEALING:where shareholder or director is personallyinvolved in a transaction with the corporation & benefits at theexpense of corp. or minority share-holders. (breach of loyaltybased on personal motives not in the best interest of corp.)

i. Arises with interested Transactions:1. Personal loan (SOX prohibits this unless purchase of

home)2. Retirement plans of board members3. Compensation of board members4. Distribution to shareholders/directors (requires

shareholders as board members)5. Purchase of directors property by board members.

ii. Test: INTRINSIC FAIRNESS TEST1. If the transaction is fair to the corporation based on

motives of director & effect on corporation, thentransaction may be valid. Burden on defendant toshow fair. (Usually there ahs not been ratification by

the board or shareholders) Marcianoa. If disinterested board or shareholders ratify

then apply the BJR. Burden on the to showtransaction is unfair. Usually will not involvefraud, waste or serious over-reaching.

b. If interested director is required for quorum& participates in meeting but does not vote,then apply intrinsic fairness test. (Usuallywhere all directors are interested).

iii. Rules of Thumb1. If a court believes the transaction is fair, it will be

upheld.2. If the transaction involves fraud, overreaching or

waste of corp. assets it will be set aside.3. If it doesnt involve elements in (2) but courts not

sure its fair, it will be upheld only where showstransaction was approved/ratified by disinterestedboard without participation by interested party afterfull disclosure of material facts.


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4. Must do something more than being a member of theboard with the initial decision.

5. Need to be clear that interested is more than voting,need personal benefit.

6. Board can elect/appoint disinterested individuals toexamine the actions of the interested parties Can haveactions dismissed after the fact.

7. Self-Dealing Transactions are voidable but are not in andof themselves illegal:

a. Sarbanes Oxley requires audit committee & mustbe persons without financial interest in thecompany, i.e. outside directors.

iv. In re Caremark Intern, Inc. Derivative Litigation: Caremark paidDoctors for referrals. Illegal Kickbacks. DOJ found violation &brought felony indictments. Caremark paid $250M to settle.Derivative action was brought to recover the losses of the

company. There was no self-dealing since the directors did notreceive any personal benefit.

1. Settlement only dealt with structural steps:a. Take steps to assure no future violations occurb. Advise patients in writing of financial

relationship between Caremark & doctor.c. Create compliance &ethics committee

2. Issue: Whether the proposed settlement appears to befair to the corporation & its absent shareholders.

a. Determine whether there was a breach of duty ofloyalty disinterested party so use BJR

b. Good Faith was examined in the context of theduty of care

i. There was no indication of self-dealing &they acted reasonably

ii. Duty of care was satisfied so there was noway to question good faith.

3. No liability will be made to directors for bad, erroneous,or stupid business decisions when the directors acted ingood faith & took reasonable steps to institute a rationalprocess.

H. SARBANES OXLEYi. New Requirements

1. Additional disclosure requirements on companies2. Expands financial responsibility of CEO, CFO & Attnys3. New Security-related crimes4. Increase the penalties for SEC violations5. Increased oversight & enforcement


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6. Establishes an Accounting Oversight Board to oversee& prosecute accounting firms & conduct audits ofpublic companies.

ii. Officers must certify annual or quarterly reports that:1. They have reviewed the report, it does not contain

any untrue statement of material fact or omission2. The company has established internal controls to

ensure material information is made known to theofficers

3. Officers have evaluated effectiveness of internalcontrols w/in 90 days & included conclusions

4. There are no material changes that could affectcontrols.

iii. Prohibits executives & directors from receiving mostpersonal loans, except home improvement, purchase, &consumer credit.

iv. Create Audit Committee independent from CoManagement to oversee & direct audit process. Will bedelisted on the exchange if fail to comply.

1. Title II: Prohibits accountants from providingconsulting services simultaneously, i.e., valuationservices, management functions, broker-dealerservices, investment banking or legal services. Canprovide tax services if approved in advance.

v. New Security-Related Crimes1. Violation to alter, destroy any record to impede or

obstruct or influence investigation. SEC may impose a fine

+ up to 20 years in prison2. Attempts to commit criminal fraud under mail fraud, wire

fraud, bank fraud, health care fraud is a violation 5years in prison.

3. Felony to retaliate vs. whistleblowers (have to disclose toa member of Congress & action has to be taken limitsimposed by Bush via EO).

vi. Causes of ACTION1. Self dealing:2. Usurping corporate opportunities:3. Misrepresentation or omissions of material

information:4. Insider trading5. Misappropriation of assets for personal use.

vii. Remedy1. Outside auditors must disclose non-audit services

rendered and that cannot provide audit and othernon-audit services.


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2. Services must be pre-approved by corporatemanagement and audit committee.

3. Accounting firms cannot provide book-keeping,accounting, and financial statements, fairnessopinions, management functions, legal services and

expert services.4. Audit committee must have procedures for

protection of whistleblowers and engageindependent legal counsel

5. CFO and CEO must certify financial statements thatcontain no material false statements or omissions.That would render financial statements to bemisleading.

I. COMMON LAW/STATE ACTION RE: FRAUDi. Common law Fraud: Elements

1. Material misrepresentation of material fact; that2. Insider knows is false or is reckless; and3. Intends that the other person rely upon it;4. Actual reliance; &5. Actual damages

ii. Common law insider trading:1. Liable to corporation per derivative action Diamond

no harm to the corporation is requirediii. Common law Misappropriation (outsider trading)

1. Codified by state lawJ. ATTORNEY LIABILITY FOR MALPRACTICE

i. Attorneys must report evidence of a material violation ofsecurities laws or breach of fiduciary duty to chief legalcounsel or CEO.

1. If action is not taken, attorney must inform auditcommittee. There is a proposed rule before the SECrequiring a noisy withdrawal, i.e., if no action istaken, then the attorney must withdraw fromrepresentation & report the withdrawal to the SEC.

ii. 3-110 Failing to Act Competently1. A member shall not intentionally, recklessly or

repeatedly fail to perform legal services withcompetence.

2. For purposes of this rule, competence in any legalservice shall mean to apply the:

a. Diligenceb. Learning & skill, &c. Mental, emotional, & physical ability

reasonably necessary for the performance ofsuch service


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3. If a member does not have sufficient learning & skillwhen the legal service is undertaken, the membermay nonetheless perform such services competentlyby

a. Associating with or, where appropriate,professionally consulting another lawyerreasonably believed to be competent, or

b. By acquiring sufficient learning & skill beforeperformance is required.

iii. 3-210 Advising the Violation of Law1. a member shall not advise the violation of any law,

rule, or ruling of a tribunal unless the memberbelieves in good faith that such law, rule, or ruling isinvalid.

2. A member may take appropriate steps in good faith totest the validity of any law, rule, or ruling of a

tribunal.iv. 3-300 Avoiding Interests Adverse to a Client

1. A member shall not enter into a business transactionwith a client or knowingly acquire an ownership,possessory, security, or other pecuniary interestadverse to a client, unless each of the followingrequirements has been satisfied:

a. The transaction or acquisition & its terms arefair & reasonable to the client & are fullydisclosed & transmitted in writing to theclient in a manner which should reasonably

have been understood by the client; (othercounsel must review terms) &

b. The client is advised in writing that the clientmay seek the advice of an independentlawyer of the clients choice & is given areasonable opportunity to seek that advice; &

c. The client thereafter consents in writing tothe terms of the transaction or the terms ofthe acquisition.

2. Discussiona. 3-300

i. not intended to apply to the agreement bywhich member is retained by client,unless the agreement confers on themember an ownership, possessory,security, or other pecuniary interestadverse to the client.

1. Such agreements is governed byrule 4-200


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ii. Not intended to apply where a member &client each make an investment on termsoffered to a general public or a significantportion thereof.

1. Example: not intended to applywhere A, a member, invests in alimited partnership syndicated bya third party. B, As client, makesthe same investment. AlthoughA &B are each investing in the samebusiness,A did not enter into thetransaction with B for thepurposes of the rule.

iii. Intended to apply where the memberwishes to obtain an interest in clientsproperty in order to secure the amount of

the members past due or future fees


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III.TRANSACTIONS INVOLVING SHARESA. ELEMENTS OF 10b5:

i. In connection with the purchase & sale of stock, a person isliable for using interstate commerce or the mails tointentionally use of any means of Interstate commerce to:

1. Defraud, make material omissions (Basic) ormisrepresentation or acts which tend to defraudanother (Ernst) or manipulative practices (Sante Fe)

2. In the purchase or sale of securities (Blue chip)3. In close or public corporations.

a. An action may be private or under the federalstatute & can result in damages that includerescission, out of pocket, & conversion.

b. Materiality is based on the ReasonablePerson Standard: whether a reasonableperson would attach importance of

significance to the information so as toinfluence his decision regarding the value ofthe stock & whether to buy or sellshares.

B. Summary of 10b5: Reaches to any activity involving the purchase& sale of stock in a close or public corporation where intent todeceive or recklessness & materiality is established.

i. Applies to public & close corporationsii. Duty to disclose timing is key

1. Applies where the person soliciting or using anintermediary misleads or deceives by omission ormisstatement.

a. Or information is disclosed to the public thatimpacts the value of stock

2. Affirmative duty to correct a misunderstanding3. Harm to the corporation is not required

iii. There is an affirmative duty to disclose required:1. If undisclosed information renders previously

disclosed public statements by corp. misleading2. If corp. has reason to believe individuals are trading

based on material information not disclosed3. Where rumors are circulated in the broker

community that although incorrect, are attributable

to the issuing corp.iv. Violation gives rise to:

1. Affirmative duty to disclose, refrain from trading, ordamages if have traded.

v. Fraud on the Market:1. Created a rebuttable presumption that if information

is material, reliance is presumed; focus on reasonablesignificance placed on the information. Basic


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vi. Uses1. Applies to all corporations2. Applies to any person (purchaser or seller)3. Applies to purchase or sale4. Intent required5. Private action or derivative action6. No exemption7. Federal action


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Diagram of 10b5 Actions

Insider Tippee/TipperOutsider - Misappropriation

AOffice Director

(10b5 Insider)

Buys stock in X-per inside info

Breach of

FiduciaryDuty

Buys stock in Y per inside info(10b5 Misappropriation)

X corp. Ycorp.Involved in tender offer

1. IfA buys stock in X bas ed upon insider information regarding a tender offer, the A is liable forInsider Trading and also liable under Williams Actregarding a tender offer.IfA buys stock in Y,then A is liable under the misappropriation.

A B

X corp. Y corp.

Breach of

FiduciaryDuty

A tells B for a benefit Buys stockin X

(10b5Tipper/Tippee)

(B knows A breach)

Buys Stock in Y

2. Insider Trading (Ti pper/Tippee)A is the Tipper, B is the Tippee

ABreach to source

BB gets info fromA

Source w/whom fiduciaryduty lies

e.g. atty-client;

guardian-ward;

principal-agent;

doctor-patient

Buy Stock

X corp. Y corp.

3. 10b5 Misappropriation: Bhas a duty of confidentiality withA, from whom he gets the information, buys stock inX and Y, then B is liable under the Misappropriation Theory.


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C. INSIDER TRADINGi. Classic insider trading:relies on a breach of a fiduciary

duty of an insider or tipper. Duties to disclose, correct, &refrain from trading. Includes agents, employees,directors, shareholders, attorneys, accountants,underwriters, or consultants.

1. Where an insider uses trades based upon nonpublicinformation about his or her corporation, which isobtained in their corporate capacity.

2. Arises out of the relationship to the Corporationii. Directors, officers, shareholders or a fiduciary who, by

virtue of their position have

1.

Access to confidential information,2. Have a fiduciary duty to refrain from trading basedupon info.

a. Directors have an affirmative duty to correctmisleading information that may beattributed to the corporation, if they havereason to know that people are trading basedupon the information.

D. TIPPER/TIPPEE LIABILITYarises when an insider tells someoneelse. Breach of fiduciary duty & personal benefit to the tipper, both ofwhich are known or should be known to the tippee.

i. Tipper Liability: liable only if the tip breaches a fiduciaryduty to corporation or shareholders; no breach if nopersonal benefit is received.

a. You can receive a benefit if you split theprofits with another or your reputation isenhanced.

ii. Tippee Liability: liable if the tipper has a fiduciary duty toshareholder not to trade:

1. If tipper has breached fiduciary duty by disclosinginformation to tippee;

2. Tippee knows or should know of breach.iii. Post OHagan Rules:1. A relation with any fiduciary falls w/in the

misappropriation & includes atty/client,executor;heir; guardian/ward; principal/agent;trustee/trust beneficiary/ doctor/patient;priest/parishioner; family members in a specialrelation to one another (presumes person is acting asan insider/tipper, not a tippee);


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2. Open questions unanswered by the case:a. If fiduciary knows the info is confidential

then it creates an inference that any tradingis based upon it; however, can overcome theinference by showing the absence of a causal

connection (Adler)3. Safe harbor exists if the purchaser or seller has a

binding contract or plan entered into before he or sheis aware of the information, & the terms of thecontract include the amount, price & date or someformula & not influence or discretion & demonstratesthat it is pursuant to a plan whose terms have notchanged.

E. MISSAPROPRIATION (OUTSIDER TRADING)i. Outsider Trading: relies on a breach of duty to the source

of the information, often an employer (not the

corporation)1. Where an outsider is trading on misappropriated

information about another corporation.2. There may or may not be a relationship but there is

access.3. Outside persons, who, by virtue of some special

relationship, e.g., contract (but who may not owe anyduty to the corporation) get access to confidentialinformation about a corporation & who trade on itmay be liable under the misappropriation theory.

ii. In Re EnronF. REMEDIES: DIRECT ACTION, SEC & DERIVATIVE

i. Rescind Contract: If stock was not resold; usually in face toface encounters

ii. Rescission Damages: if stock is resold; Damages = Buyersprofit (price bought stock price sold stock).

iii. Out of pocket Damages: Difference between price youbought or sold stock for & what stock is worth.

iv. Cover or Conversion: difference between the pricepurchased & the market price at which you could sell orrepurchase once fraud is revealed; duty to mitigate

v. No punitive damages in 10(b)(5); may be available in statestatutes.

G. DAMAGES Examplei. Lizzy publicly reports that the sales of a new product produced

by a corporation will be disappointing. At the time the stock istrading at $25/share, although stock would normally trade at$27/share if the potential were known.

ii. After the bad news, the stock falls to $20/share & Gullible sellsto Lizzy. Later, rumors circulate that Lizzys announcement is


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overly pessimistic & the stock rises. Lizzy sells at $28.Eventually, Lizzys prognosis is determined to be false & thestock jumps to $31/share.

iii. Gullible sues Lizzy. At the time of the suit, the market price is$33/share.

1. Remedies:a. RescissionDamages (Because stock was resold):$28-$20 = $8.

H. WILLIAMS ACT:i. 14(e) imposes a duty to disclose on any person who trades

in stock sought for tender offer while in possession ofmaterial information which he knows or should know isnonpublic & has acquired it directly or indirectly from anoffering person, issuer, officer, partner, or employee. Noduty if dont purchase or sale.

ii. 14e imposes broader liability because no breach isrequired

iii. Establishes a specific duty to disclose or refrain fromtrading.

iv. Applies to:1. Conversation re tender offer (company is going to buy

another company out) which are nonpublic fortippers & tippees; &

2. Extends to offering person who sends nonpublicletter to subject co. noticing a proposed tender offerwith specified terms & price.

a. Management cannot purchase or sell or causethe purchase or sale per a tender offer norcan unaffiliated persons who are told bymanagement purchase or sell

3. A person who steals, converts or misappropriatesmaterial, nonpublic information

4. If offeror tells another of intent to make a tenderoffer & person tells 3rd person that offer will be made& 3rd person knows or should know information isnonpublic.

a. No need to prove breach of duty for personalbenefit.

v. TENDER OFFERS:Uses proxy solicitation & statements inaddition to tender offer to gain control. (WilliamsAct 14(e),SEA 1934, 10b).

1. Cash Tender Offer business shares at a premium, usu15-20% above market

2. Two-tier acquisition -front end loaded-partial cash offerwith subsequent offer to buy at less favorable rates, 2nd


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offer is to mop up & set up to compel shareholder toaccept the terms, e.g. offer securities; not used widely

3. Exchange Offer offer includes a stock swap, i.e.exchange of stock in one company for stock in another orincludes case & stock swap package of its own securities

cash debt & equity.4. Leveraged buyout purchased with borrowed money.

It is a variation on two tier offer where acquirer (mgmt.,another corporation, or raider) buys all or most ofoutstanding stock of the target at a premium for anamount that is financed through short-term bridge loans,or low-grade high interest debt such as junk bonds; with acash out or mop-up for the remaining. Repayment of thedebt becomes the obligation of the target company & ispaid off over time.

a. The new debt may be satisfied by: selling offdivisions of the old company, reserves, or cashflow. If can cover debt, then the corporation hassuccessfully leveraged debt to buy, if not then itgoes into bankruptcy as overextended(insufficient cash to cover debt). All transactionsmust be made at arms length & subject to ruleson self-dealing, corporate opportunity, & 10b.

I. Rules Regarding Director & Officer Investmentsi. Ok if periodic investment program already approved & simply

making investment as part of plan.ii. OK to buy stock 1 wk. after annual report is issued for 30 days.

iii. May be OK for trades if contact CEO before trade to see if anyinfo needs to be made public in the following circumstances:

1. After quarterly reports issued;2. Making wide information dissemination regarding the

status of company, e.g. proxy statement re merger oraction;

3. When relative stability in market.iv. Avoid 3-4 months before an announcement; prior to release of

earnings, dividends must wait until after release ofinformation & dissemination.

v. Same thing applies to stock optionsvi. If disclosing the information to board jeopardizes corporate

security, need not reject option but refrain from exercising ituntil full disclosure. Post Ratification may be ok

J. Transactions Requiring Shareholder Approvali. Types of Transactions: Initiated by the board resolution & may require

shareholder approval per art. of inc. or bylaws.1. Election of board of Directors:Directors nominate a slate of

directors to be voted on at the annual meeting for a term, (terms can


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be staggered or fixed). Unless articles provide otherwise, directorsmay set compensation for directors & officers.

2. Merger: 2 or more companies merge together so one is dissolved.a. MBCA 11.02 Requires a plan of merger including:

i. Name of co, manner of converting the shares ofmerging company, articles of incorporation, &

oth

er provisions required per th

e bylaws.b. Merger can be effected by a tender offer, i.e., shareexchange or purchase. The shareholders of all classes ofstock of both corporationshave the right to approve perthe articles of incorporation unless the corporation willsurvive or it is a merger of parent & subsidiary.

3. Sale of all of the Assets: Shareholders have the right to approve asale of all or substantially all of the assets outside of the ordinarycourse of business. MBCA 12.01

4. Sale of Stock: Buy controlling interest via a tender offer & then cash-out merger.

5. Dissolution of Corporation: Board ofShareholders may propose todissolve the corporation under a plan of dissolution. MBCA 14.01

6.

Amendment of Articles of incorporation or bylaws:E

very class ofshareholders affected by the action has the right to vote on theamendment.

7. Removal of Directors:Shareholders may remove a director unlessarticles require removal for cause. Removal must be specificallynoticed in the meeting. MBCA 8.08.

8. Ratification of Director Action: Where directors are interested &decide whether or not to ring a shareholder derivative action afterwritten demand. Required to file a report after reasonableinvestigation to determine if in best interests. MBCA 7.24-744


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IV.PROXY REGULATIONA. Relates to the use of interstate commerce to solicit proxies or

consent or authorization.i. Must file a registration before broker can effect

transaction on national exchange.ii. Prohibits false or misleading information in proxy

solicitations & statementiii. Proxy must be for specific; notice of the meeting & fully

disclose the proposed action &options regarding voting.B. Proxy Solicitation Rules:

i. It is a violation of SEA 14(a) to include false or misleadingmaterial facts or omit material facts in proxy statement.

The rule applies for:1. Predictions of future market values;2. Impugn the character, integrity or personal

reputation or makes charges regarding illegal orimmoral conduct w/o factual foundation;

3. Failure to identify document as a proxy statement,form of proxy or other soliciting material;

4. Claims regarding the results of a solicitationC. Contents for Proxy Solicitation

i. Compensation Plans must include:1. Material features of plan;2. Each class of persons in each class & basis forparticipation;3. Number of persons in each class & basis for participation4. Benefits to be received; &5. Existing plans in effect during last 3 years.

ii. Retirement or Pension Plans must include:1. Amount necessary to fund the plan for past services;2. Period over which the pension is paid; &3. Annual payments for current services.

D. Basic points Re: Proxy Regulationi. Proxy Solicitations & statements for public corporations

relate to such matters as electing board, approvingcompensation plan for directors, agree to merger,consolidation or some fundamental change in corp.structure. Solicitation must be registered with the SEC.Cannot make material representation or misleadingstatements.

E. SHAREHOLDER PROPOSALS: Governed primarily by state law,SEC 1934 implies a private action when proper, but has higher


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standard to overcome. Can request not action letters.Shareholders seek to include proposals that are designed tochange policies of the corporation indirectly w/o going throughthe board.

i. 3 categories of shareholder proposals submitted forinclusion:

1. Corporate Governance-structure & composition of theboard, poison pills. (55% Most includable)

a. Special class of stock created for a bidder thatrequires that the corp. redeem at higherprice if unsuccessful, or allows shareholdersto acquire additional shares at a discount todilute the value

b. Generally favorably treated by SEC in recentyears.

2. Operational Executive Compensation,Production/Business Matters, CompanyCommunications (49% SEC includable)

3. Social/Political: environmental, political, military &labor. (41% Most excludable)

a. If management excludes proposal, then boardmust give shareholder opportunity to cureany defect.

ii. General Rules1. Notice requirements are defined by Bylaws for

annual & special meetings.2. Proxy can allow person to vote in a specific way for or

against a proposal, leave to the discretion of theboard to vote shares. You can show up & defeat proxysubmitted.

3. Expenses for proxy fight have to be borne by theperson submitting the proposal. If they are successful,& take over the board, then can requestreimbursement

4. Can request no action letter from the SEC that therequest was properly excluded.

5. Submit proposals within 120 days of mailing.Proposal has to be registered with SEC & identified as

proxy. All of the pertinent information needs to beincluded

6. There are word limits of 500 words (2pp)7. If management collects proxies that give the authority

to vote on matters within their discretion, then if amotion from the floor is made & supported byshareholders, then the board can use its discretionwhether to approve or not.


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iii. Board Approval ofProposals: Reasons to exclude: Board isnot required to include any proposal in a proxy re:

1. Violate state law2.

Contrary to

P

roxy rules3. Redress a personal claim or grievance,4. Relates to operations of less than 5% of total assets, -

unrelated to company business 5. Deals with Ordinary business operations,6. Related to election of office7. Counter to proposals submitted by majority board

not required to submit conflicting proposals orduplicative,

8. Similar to previous proposals that have failed in thepast

9. Relates to specific cash or stock dividend10. Not a proper subject asks that a study be conductedwithout compelling specific action

11. Beyond the authority of the corporation12. Moot because the board is already doing it

BUSINESS TRANSACTIONS

Board of Directors

-Proposals

-Info e.g. financial-Annual Report

Shareholders

Record Date

Notice

File w/SEC Info

Only

Management

Disclosure

Financial Analysis

Fraud Misrepresentation

State Action for Fraud

(No fed Proxy Fraud) 10b5

Seek Vote

Proxy Solicitation Proxy Fraud

-Misrepresentation or Omission

-Materiality establish reliance

-Loss Causation(Causal link vote & transaction)

Annual

Meeting

Special

Meeting

Amend

Articles of

Incorporationor Bylaws

ElectDirectors

Compensation Plan Pension Plan -Tender Offer

-Merger

-Sale ofAssets-Takeover

Self-dealing ifAll

directors areinterested


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V. RIGHTS & REMEDIESA. Inspection of RecordsB. Remedies for Actions

i.

Regulation D:1. Register for IPO, exemptions:2. SEC can deregister a company, require amended S1

form with corrected information; cancel or terminatethe offering; & impose fines on corporation orprincipal persons where trading has occurred to 3times the profit or $1M.

a. S1:Registration is effective 20 days after it isfiled.

i. Regulation 230.52 Requires thatsecurities must be registered before

they can be resold after initialpurchase.

ii. Preemptive right of the company to acquire shares doesnot apply to stock given as compensations per MBCASection 6.30(b)(3).

1. Does apply to options as well as stock purchasesiii. Violations of fiduciary Duty:

1. Fired if officer, removed from board; turn over profitsor constructive trust on assets.

iv. Insider Trading:1. Civil penalties under 10b, private direct action for

damages; derivative action for breach of duty, Section21 provides SEC can impose penalties can be 3 timesprofit or loss avoided, Or v. controlling persons $1Mor 3 times profit. Removed from the board.

2. Duty to disclose or correct public statementsv. Proxy Regulation:

1. Failure to comply with the rules can result inexcluding the proposal, or request No action Letter,i.e. SEC will take no action v. the company.

2. Enjoin meeting, file corrected statement, invalidatevote.

a. Request for proxy list response w/in 5 days& include list of # holders, type & class ofstock, & cost of mailing

b. If hostile action or board refuses to includethen can sue for the list & send outinformation to shareholders.

c. Must front the cost bit if successful, willcontrol the board & can seek reimbursement.


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vi. Shareholder Proposals:1. Only 1 proposal/shareholder.2. Proposals have to be received within 4 months OR if

the date has moved by more than 30 days then withina reasonable time.

vii. Exclude proposals that include false or misleadinginformation.viii. Regulation FD (Fair Disclosure)

1. If make selective disclosure to analysts privately,then must publicly disclose the information.

2. Disclosure to analysts privately, then must publiclydisclose the information. Disclosure via press release,wire service, email is required if intentional thensimultaneously, or unintentional then make promptdisclosure.

3. Can also file statement with SECa. If the information was included in a publicstatement, e.g. annual report, then not-

material = non-public, BUT:b. If you change what was included in statement

so private info would change then mayrequire disclosure.

VI.SUMMARY OF ACTIONS AGAINST DIRECTORSA. Actions v. Directors, officers by corp.;

i. If the facts pertain to taking advantage of an opportunityto the disadvantage of minority shareholders, then theprinciples that may apply are

1. Self dealing interest transaction2. Corporate Opportunity: ALI test re: line of business,

expectancy3. Sale of control-premium4. Waste of corporate assets overreaching

ii. The breach may arise out of a breach of duty of loyalty,care & good faith to the corp.

1. The obligations will be judged based on extent ofdisclosure, & disinterested approval or ratification.

2. Apply either the IF Test or BJR.3. Factors to be considered (defenses) are

reasonableness or investigation & informationprovided, extent of waste, looting, or fraud & ifauthorized by the bylaws.


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iii. If the remedy is for the benefit of the corporation, file ashareholder derivative action where demand must bemade, or if futile-facts alleged to support.

1. Both actions to bring an action & underlyingtransaction may be judged by BJR.

2. Damages are constructive trust or disgorge profits,rescission.B. Actions Regarding shares misappropriations, 10b5, 14(e)

Williams Act (Tender offer)i. 10b, 10b(5) apply to fraud or deception per a purchase or

sale of securities: intent to defraud, purchase or sale, &materiality.

1. Reliance may be presumed if information is materialor reasonable person attach importance (fraud in themarket).

2. Williams Act applies to use of non-public informationrelated to trades in a tender offer.

a. The existence of a relationship to the sourceor the corporation is not required to imposeliability.

3. Action can be brought in Federal court by SEC forviolation of securities laws, private person whobought or sold, the corp. under a derivative action (bya shareholder); or in state court under state blue skylaws (actions have been narrowed).

4. Remedies:a. Rescission, rescission charge (price bought

price resold), out of pocket (purchase or saleprice & what was worth), cover (purchaseprice market price once disclosed); nopunitive damages but,penalties may beimposed by SEC.

Business Organizations Fall 2010 Outline for Final Exam

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