Business associations

d) Statutory Duties and Liabilities--in addition to general duty of care, federal and state laws also impose certain duties and liabilities, e. g., registration requirements under the Securities Act of 1933, liability for rule 10b-5 violations, liability for illegal dividends. Some statutes also impose criminal liability on corporate managers for unlawful corporate actions.

C. OFFICERS

1. ELECTION--officers are usually elected by the board of dirs. Some statutes permit election of officers by shs.

2. AUTHORITY OF CORPORATE OFFICERS (liability of corp to outsiders) --only authorised officers can bind the corp. Authority may be: actual (expressed in bylaws or by valid board resolution), apparent (corp gives third parties reason to believe authority exists), or power of position (inherent to position). If ratified by the board, even unauthorised acts can bind the corp.

a) Authority of President--the majority rule is that the president has the power to bind the corp in transactions arising in regular course of business. 3. DUTIES OF CORPORATE OFFICERS--the duty of care owed by a officer is similar to that owed by dirs (and sometimes higher).

D. CONFLICTS OF INTEREST IN CORPORATE TRANSACTIONS.

1. DUTY OF LOYALTY--because of their fiduciary relationship with the corp, officers and dirs have the duty to promote the interests of the corp without regard for personal gain.

2. BUSINESS DEALINGS WITH THE CORPORATION--conflict of interest issues arise when a corp transacts business with one of its officers or dirs, or with a company in which an officer or dir is financially interested.

a) Effect of Self-Interest on Right to Participate in Meeting--most statutes permit an «interested» dir to be counted toward quorum, and interested dir’s transactions are NOT automatically voidable by the corp because the interested dir’s vote was necessary for approval.

b) Voidability Because of Director’s Self-Interest--today, such transactions are voidable only if unfair to the corporation. The burden of establishing fairness is on the interested director. Note that a dir’s failure to fully disclose material facts may be per se unfair.

1) Unanimous shareholder ratification--if, after full disclosure, shareholder ratification is unanimous, the corp will be estopped from challenging the transaction with the interested dir (except at to creditors).

I) Less-than-unanimous ratification--courts then will look at whether the majority shares were owned or controlled by the interested director. Courts are more likely to uphold ratification by a disinterested majority so as to preclude the transaction from being attacked by the corp or by a sh in a derivative suit.

2) Statutes--most statutes provide that such transactions are NOT voidable if: (1) approved, after full disclosure, by a disinterested board majority or by majority of shs, or (2) the transaction is fair to the corp notwithstanding disclosure.

I) «Interested» --an «interested» dir or officer is one who has a business, financial, or familial relationship with a party to the transaction that would reasonably affect the person’s judgement so as to adversely affect the corp.

c) Remedies--the corp may rescind, or affirm and sue for damages.

3. INTERLOCKING DIRECTORATES--generally, transactions between corps with common dirs are subject to the same rules of interested director transactions. There is no conflict of interest if one corp is the wholly owned subsidiary of the other. However, a question of fairness arises where the parent owns only a majority of the subsidiary’s shares.

4. CORPORATE OPPORTUNITY DOCTRINE (Also see duty of loyalty) a) Definition--COD bars dirs from taking any business opportunity belonging to the corp without first offering it to the corp. If the corp is unwilling to pursue an opportunity (after an independent board is fully informed of the opportunity), then the dir may pursue it.

b) Defenses (available in most, but not all jurisdictions): 1) Inability--If the corp is legally or financially unable to take the opportunity, then the dir generally may take advantage of it. (But the question of who caused the financial inability is quite relevant. Example: Irving Trust Co--the defense of inability was rejected).

2) Rejection, abandonment, or approval--then the fiduciary has a valid defense.

c) Remedies--constructive trust or damages--the fiduciary must account to the firm for all the profits he has made as a result of usurpation.

d) Definition of a Corporate Opportunity: 1) Line of business test--does the firm have fundamental knowledge, practical experience, and ability to pursue the opportunity? If yes, then it is within the firm’s line of business. It should be a natural fit, and not a mere desire by a firm to pursue the opportunity.

2) Interest/expectancy test e) Application--Guth Rule and Corollary: 1) Guth rule (offered in corporate capacity) --if there is presented to O/D a business opportunity which the corp is (1) financially able to undertake, which is from its nature (2a) in the line of business and is of practical advantage to it OR (2b) is one in which the corp has an interest or reasonable expectancy (under an established corporate policy or plan), and, (3) by embracing the opportunity the self-interest of the dir will be brought into conflict with that of his corp, then officer or dir may NOT take the opportunity.

2) Guth corollary (a safe harbor; satisfy all provisions and dir can take) --if a business opportunity (1) comes to O/D in his individual capacity and (2) is not essential to the corp and is (3) one in which corp has no interest or expectancy, then the O/D can treat it as his own, IF he has not taken corporate resources to pursue the opportunity.

I) «Essential» --indispensably necessary to the continued viability of the firm; ii) Individual or corporate? Look at O/D capacity to determine how offer was made 5. COMPETING WITH CORPORATION--such competition by a dir or officer may be a breach of fiduciary duty even when the competing business is not a corporate opportunity 6. COMPENSATION FOR SERVICES TO THE CORPORATION--the compensation plan must be duly authorized by the board, and its terms must be reasonable. Good faith and the BJR ordinarily protect disinterested dirs from liability to the corp for approving compensation.

a) Publicly Held Corporations--The SEC has authorised shs to make proposals about executive pay in management’s proxy statements. Further, the tax code now limits expense deductions for executive pay over $ 1mln, unless it is tied to the corp’s performance.

b) Past and Future Services--compensation for past services is generally invalid. Compensation for future services is proper if there is reasonable assurance that the corp will receive the benefit of the services.

VI. INSIDER TRADING--purchase or sale of securities by someone with access to material non-public information. It may be illegal. It affects corps with more than $ 1 mln in total assets and with at least 500/750 shs.

a) Who may be hurt by insider trading:

1) Target shareholders--they sell too early; 2) Other arbitrageurs--they lose a portion of the gain that they make from honest effort 3) Other issuers--they lose confidence in the stock market 4) The acquiring company--insider trading drives up their cost of acquisition, since the target may adopt defensive measures otherwise not in place.

b) Possible Sources of Liability: 1) Common Law; 2) 10b-5 traditional; 3) 10b-5 misappropriation theory (O'Hagan); 4) Mail or wire fraud; 5) 14e-3; 6) Statutory liability under 16(b) --insiders are forced to give their profits to the corp, if the y buy and sell securities within a 6-month period regardless of whether they are using insider info. (Need to know 2,3,6) c) O’Hagan--insider trading violation where a partner in law firm took info rom his firm regarding the firm’s client’s plans for acquisition of Pillsbury and used that info to buy shares in Pillsbury d) Penalties For Insider Trading--ITSA (Insider Trading Sanctions Act) --3 measures: 1) Out-of-pocket measure--if a sh buys a share for $ 10, while in fact it costs $ 9, his out-of-pocket expense is $ 1.

2) Causation-in-fact--because an insider engaged in insider trading, it caused a loss 3) Disgorgement--we look at D’s profit. ITSA measures the damage to sh by the amount of profit that D received from the transaction.

2) SEC civil penalties--treble damages; SEC may seek penalty capped by three times profit gained or loss avoided.

A. COMMON LAW--under the majority rule, there was no duty to disclose to the shs inside info affecting the value of shares. Therefore, the protection of investors was very weak.

a) For lability to exist there should be: 1) At least fraud or deceit upon purchasers; 2) May also be a device or scheme; 3) May also be an implied misrepresentation.

b) Two Elements (relationship and unfairness):

1) Relationship--existence of a relationship giving access, directly or indirectly, to information intended to be available for a corporate purpose and no other.

I) Insiders include at least officers, dirs, controlling shs (In re Cady Roberts) ii) Persons charged with confidentiality by contractual or fiduciary relationship 2) Unfairness--inherent unfairness that results when a party takes advantage of such information knowing it is unavailable to person with whom he is dealing.

B. SECURITIES EXCHANGE ACT OF 1934--IN GENERAL--the act superseded common law. Section 12 of the Act requires registration of any security traded on a national exchange, or any equity security (held by 500 or more persons) of a corp with assets exceeding $ 5 million.

C. SECTION 10(B) AND RULE 10B-5--section 10(b) prohibits any manipulation or deception in the purchase or sale of any security, whether or not it’s registered. Rule 10b-5 prohibits the use of the mails or other instrumentality of interstate commerce to defraud, misrepresent, or omit a material fact in connection with a purchase or sale of any security.

1. COVERED CONDUCT--rule 10b-5 applies to nondisclosure by dirs or officers, as well as to misrepresentations. It applies not only to insider trading but also to any person who makes a misrepresentation in connection with a purchase or sale of stock.

2. COVERED SECURITIES--rule 10b-5 applies to the purchase or sale of any security, registered or unregistered. a jurisdictional limitation requires that the violation must involve the use of some instrumentality of interstate commerce.

3. WHO CAN BRING SUIT UNDER 10B-5--private plaintiffs and the SEC. Private plaintiffs must be either purchasers or sellers of security.

4. MATERIALITY--for rule 10b-5 to apply, the information misrepresented or omitted must be material (i. e., a reasonable sh would consider it important in deciding whether to buy or to sell).

5. FAULT REQUIRED (SCIENTER) --a defendant is not liable under rule 10b-5 if he was without fault or merely negligent. The scienter requirement is satisfied by recklessness or an intent to deceive, mislead, or convey a false impression. Scienter is also required for injunctive relief.

a) Recklessness Defined: 1) D knew the hazard and proceeded nonetheless (subjective test); 2) D proceeded despite what a reasonable person would perceive (objective test); b) Recklessness Under PSLRA: 1) Knowing conduct-- yields jointly and severally liable; 2) Non-knowing conduct (e. g., recklessness) --yields fair share (proportionate liability), found in accordance with special interrogatories.

6. CAUSATION AND RELIANCE--a plaintiff must prove that violation caused a loss (i. e., he must establish reliance on the wrongful statement or omission). However, in omission cases, there is a rebuttable presumption of reliance once materiality is established.

a) Fraud On The Market--where securities are traded on a well-developed market (rather than in a face-to-face transaction), reliance on a misrepresentation may be shown by alleging reliance on the integrity of the market.

b) Face-to-Face Misrepresentations--a plaintiff can show actual reliance in these cases by showing that the misrepresentation was material, testifying that he relied upon it, and showing that he traded soon after misrepresentation.

7. WHEN NONDISCLOSURE CONSTITUTES a VIOLATION

a) Mere Possession of Material Information--generally, nondisclosure of material, non-public information violates rule 10b-5 only when there is a duty to disclose independent of rule 10b-5 b) Insider Trading--insiders (dirs, officers, controlling shs and corporate employees) violate rule 10b-5 by trading on the basis of material, non-public info obtained through their positions. They have a duty to disclose before trading.

c) Misappropriation--the liability of noninsiders who wrongfully acquire (misappropriate) material non-public info has not been ruled upon by the US Supreme Court, although some lower level federal courts have imposed criminal liability.

1) Duty to Employer--using the misappropriation theory, criminal liability under rule 10b-5 has been imposed where an employee trades on info used in violation of the employee’s fiduciary duty to his employer. An employee’s duty to «abstain or disclose» with respect to his ER does NOT extend to the general public. However, the Insider Trading and Securities Fraud Enforcement Act of 1988 makes any person who violates rule 10b-5 by trading while in possession of material, non-public info liable to any person who, contemporaneously to the transaction, purchased or sold securities of the same class. Liability is limited to the defendant’s profit or avoided loss.

2) Mail and wire fraud--the application of the federal mail and wire fraud statute to this situation lessens the importance of the misappropriation theory in imposing criminal liability under rule 10b-5.

3) Special rule for tender offers--once substantial steps toward making a tender offer have begun, it is a fraudulent, deceptive, or manipulative act for a person possessing material information about the tender offer to purchase or sell any of the target’s stock, if that person knows that the info is nonpublic and has been acquired from the bidder, the target, or someone acting on the bidder’s or the target’s behalf.

d) «Disclose or Abstain» --nondisclosure by a person with a duty to disclose violates rule 10b-5 only if he trades (Cady rule) 8. LIABILITY OF NONTRADING PERSONS FOR MISREPRESENTATION--a nontrading corp or person who makes a misrepresentation that could cause reasonable investors to rely thereon in the purchase or sale of securities is liable under rule 10b-5, provided the scienter requirement is satisfied.

9. LIABILITY OF NONTRADING CORPORATION FOR NONDISCLOSURE--the basic principle is «disclose or abstain.» Thus, a nontrading corp is generally not liable under rule 10b-5 for nondisclosure of material facts.

a) Exceptions--a corp has a duty to: 1) Correct misleading statements (even if unintentional); 2) Update statements that have become materially misleading by subsequent events; 3) Correct material errors in statements by others (e. g, analyst’s report) about the corp, but only if the corp was involved in the preparation of the statements; and 4) Correct inaccurate rumors resulting from leaks by the corp or its agents.

10. TIPPEE AND TIPPER LIABILITY--a person, not an insider, who trades on info received from an insider is a tippee and may be liable under rule 10b-5 if he received info through an insider who breached fiduciary duty in giving the info, AND the tippee knew or should have known of the breach (Dirks) a) Breach of Insider’s Fiduciary Duty--whether an insider’s fiduciary duty was breached depends largely on whether the insider communicated the info to realize the gain or advantage. Accordingly, tips to friends or relatives and tips that are a quid pro quo for a past or future benefit from the tippee result in fiduciary breach. Note that if a tippee is liable, so is the tipper.

11.» TEMPORARY INSIDERS» --corporate info legitimately revealed to a professional or consultant (e. g., accountant) working for the corp may make this person a fiduciary of corp 12. AIDERS AND ABETTORS--liability cannot be imposed solely because a person aided and abetted the violation of the rule.

13. APPLICATION OF RULE 10B-5 TO BREACH OF FIDUCIARY DUTY BY DIRECTORS, OFFICERS, AND CONTROLLING SHAREHOLDERS.

a) Ordinary Mismanagement--a breach of fiduciary duty not involving misrepresentation, nondisclosure, or manipulation does NOT violate rule 10b-5; b) Misrepresentation or Nondisclosure--if this is the basis of a purchase from or sale to the corp by a dir or officer, the corp can sue the fiduciary under rule 10b-5 and also for breach of fiduciary duty. If the corp doesn’t sue, a minority sh can maintain a derivative suit on the corporations behalf.

c) Purchase or Sale By Controlling Shareholder--when a corp purchases stock from or sells stock to a controlling sh at an unfair price, and material facts aren’t disclosed to minority shs, a derivative action may lie if the nondisclosure caused a loss to the minority shs. The plaintiffs must establish causation by showing that an effective state remedy (e. g., injunction) was foregone because of nondisclosure.

14. BLUE CHIP RULE--PRIVATE PLAINTIFF--a plaintiff can bring a private cause of action only if he actually purchased or sold the relevant securities. «Sale» includes an exchange of stock for assets, mergers and liquidations, contracts to sell stock, and pledges. The SEC can bring action under rule 10b-5 even though it has neither purchased or sold securities.

15. DEFENSES

a) Due Diligence--if a plaintiff’s reliance on a misrepresentation or omitted fact could have been prevented by his exercise of due diligence, recovery may be barred. Mere negligence does NOT constitute a lack of due diligence, although a plaintiff’s intentional misconduct and his own recklessness (if D was merely reckless) will bar recovery.

b) In pari delicto--a private suit for damages under rule 10b-5 will be barred if: 1) The plaintiff bears substantially equal responsibility for the violations, AND 2) Preclusion of the suit would not significantly interfere with the enforcement of securities law.

16. REMEDIES

a) Out-of-pocket Damages--this is the difference between the price paid for stock and its actual value.

1) Compare--benefit-of-the-bargain damages--these are measured by the value of the stock as it really is and the value it would have had if a misrepresentation had been true.

2) Standard measure of conventional damages--out-of-pocket damages is the standard measure in private actions under rule 10b-5; benefit-of-the-bargain damages are usually not granted.

b) Restitutionary Relief--this may be sought instead of conventional damages: 1) Rescission--returns the parties to their status quo before the transaction 2) Rescissionary or Restitutionary damages--money equivalent of rescission 3) Difference between conventional damages and Restitutionary relief--out-of-pocket damages are based on the P’s loss, while Restitutionary relief is based on the D’s wrongful gain. Rescission or Rescissionary damages may be attractive remedies when the value of the stock changed radically after the transaction. However, Restitutionary relief is usually unavailable in cases involving publicly held stock.

c) Remedies Available to the Government--although the SEC cannot sue for damages, it can pursue several remedies including special monetary remedies: 1) Injunctive Relief--the SEC often seeks injunctive relief accompanied with a request for disgorgement of profits or other payments that can be subject to criminal sanctions (fines and jail sentences) and civil penalties (up to three times the profit gained or loss avoided).

17. JURISDICTION, VENUE, AND SERVICE OF PROCESS--suits under 10b-5 are based on the 1934 Act, and exclusive jurisdiction is in the federal district courts. State claims arising out of the same transactions may be joined with the federal claim under the supplemental jurisdiction doctrine. Venue can be wherever any act or transaction constituting a violation occurred, or where the D is found or transacts business. Process can be served where the D can be found or where he lives.

18. STATUTE OF LIMITATIONS--the 1934 Act contains no SOL; however, the SCt has held that private actions must be brought within one year after discovery of the relevant facts and within three years following accrual of the cause of action. The tolling doctrine is inapplicable.

a) Exceptions--the time limitations don’t apply to all rule 10b-5 private actions, e. g., SEC limitations period of five years for private suits by contemporaneous traders against purchasers or sellers who violate rules regarding trades while in possession of material, non-public information. Further, the SEC is not subject to any limitations period in civil enforcement actions.

D. SECTION 16 OF THE 1934 ACT--Section 16 concerns purchases followed by sales, or sales followed by purchases, by certain insiders, within a six-month period.

1. FIRMS AND SECURITIES AFFECTED UNDER SECTION 16--Section 16 applies to those firms and securities that must be registered under section 12 of the 1934 act.

a) Reason--16(a) references registered securities under S12; S12(a) and 12(g) create the registration requirement for securities; S12(g) creates an asset ($ 1 mln total) and distribution (500 to 700 depending on timing); 16(b) references «such» officers, etc., which refers to sub (a) b) Note--trading in all of a corp’s equity securities is subject to section 16 if any class of its securities is registered under section 12.

2. DISCLOSURE REQUIREMENT--Section 16(a) requires every beneficial owner of more than 10% of the registered stock and directors and officers of the issuing corp to file periodic reports with the SEC showing their holdings and any changes in their holdings.

a) Who is an Officer (16a-1f) --issuer's president, principal financial director, principal accounting officer, any vice-president of the issuer in charge of a principal business unit, any other officer who performs similar policy-making functions for the issuer.

3. LIABILITY--to prevent the unfair use of information, section 16(b) allows a corp to recover profits made by an officer, dir, or more-than-10% beneficial owner on the purchase and sale or sale and purchase of its securities within a six-month period.

a) Coverage--Section 16(b) does NOT cover all insider trading and is NOT limited to trades based on inside info. The critical element is short-swing trading by officers, dirs, and more-than-10% beneficial owners.

1) Note--beneficial owner must own 10% or more BOTH at he time of sale and purchase to be liable under 16(b).

b) Calculation of short-swing profit--the profit recoverable is the difference between the price of the stock sold and the price of the stock purchased within six month before or after the sale.

1) Multiple transactions--if there is more than one purchase or sale transaction within the six-month period, the transactions are paired by matching the highest sale price with the lowest purchase price, the next highest price with the next lowest price, etc. a court can look six month forward or backward from any sale to find a purchase, or from any purchase to find a sale c) Who May Recover--the profit belongs to the corp alone. Although not a typical derivative action, if the corp fails to sue after a demand by a sh, the sh may sue on the corp’s behalf. The cause of action is federal, so there is no posting of security requirement, and no contemporaneous sh requirement. Remedy: 1) All sales and purchases within 6 months are included; 2) Damages calculated as to maximise the gain to he company; 3) Match highest sale price against lowest purchase price within relevant period; continue until you can go no further.

d) Insiders--insiders are officers (named officers and those persons functioning as officers), dirs (actually serving or who authorised deputization of another), and beneficial owners of more than 10% of the shares. Insider status for officers and dirs is determined at the time they made a purchase or sale. Transactions made before taking office is NOT within section 16(b), but those made after leaving office are subject to the statute if they can be matched with a transaction made while in office. Liability is imposed on a beneficial owner only if he owned more than 10% of the shares at the time of both the purchase and sale.

e) «Purchase or Sale» --this includes any purchase of stock. Unorthodox transactions that result in the acquisition or deposition of stock (e. g., merger for stock, redemption of stock) are also purchases and sales.

E. SECTION 16(B) COMPARED TO RULE 10B-5:

a) Covered Securities--Section 16(b) applies to securities registered under the 1934 act; rule 10b-5 applies to all securities.

b) Inside Information--Section 16(b) allows recovery for short-swing profits regardless of whether they are attributable to misrepresentations or inside info; rule 10b-5 recovery is available only where there was a misrepresentation or a trade based on inside info.

c) Plaintiff--recovery under section 16(b) belongs to the corp, while rule 10b-5 recovery belongs to the injured purchaser or seller.

d) Overlapping Liability--it is possible that insiders who make short-swing profits by use of inside info could be liable under both section 16(b) and rule 10b-5.

F. COMMON LAW LIABILITY FOR INSIDER TRADING--insider trading constitutes breach of fiduciary duties owed to the corp, so the corp can recover profits made from insider trading a) Common Law Liability Compared To Section 16(b) Liability--both common law and section 16(b) liability run against insiders and in favour of the corp. However, unlike section 16(b), the common law theory applies to all corps (not just those withregistered securities), recovery can be had against any corporate insider, the purchase and sale is NOT limited by a six-month period, and the transaction must be based on the inside info.

b) Common Law Liability Compared to Rule 10b-5 Liability--the theories of recovery are similar except that under the common law recovery runs to the corp (not to the injured purchaser or seller), there is no purchaser or seller requirement, and noninsiders (tippees) have not yet been held liable.

VII. RIGHTS OF SHAREHOLDERS

A. VOTING RIGHTS

1. RIGHT TO VOTE IN GENERAL--shs may generally vote for the election and removal of dirs, to amend the articles or bylaws, and on major corporate action or fundamental changes.

a) Who May Vote--the right to vote is held by shs of record as of the record date; b) Restrictions on Right--shares may be either voting or nonvoting, or have multiple votes per share.

2. SHAREHOLDER MEETINGS--generally, shs can act only at meetings duly called and noticed at which a quorum is present.

a) Compare--informal action--statutes permit sh action without a meeting if there is unanimous written consent of all shs entitled to vote.

3. SHAREHOLDER VOTING

a) Straight Voting--this system of voting allows one vote for each share held and applies to all matters other than director elections, which may be subject to cumulative voting. Certain fundamental changes (e. g., merger) frequently require higher shareholder approval.

b) Cumulative Voting For Director--this system allows each share one vote for each director to be elected, and the votes may be cast all for one candidate or divided among candidates as the sh chooses, thereby helping minority shs to elect a dir. Cumulative voting may be mandatory or permissive.

4. VOTING BY PROXY--a proxy authorises another person to vote a shareholder’s shares. The proxy usually must be in writing, and its effective period is statutorily limited unless it is validly irrevocable.

a) Revocability--a proxy is normally revocable by the sh at any time, although it may be made irrevocable if expressly stated and coupled with an interest in the shares themselves. Absent written notice to the corp, the death or incapacity of a sh does NOT revoke a proxy. a sh may revoke a proxy by notifying the proxy holder, giving a new proxy to someone else, or by personally attending the meeting and voting.

b) Proxy Solicitation--almost all shs of publicly held corps vote by proxy. Solicitations of proxies are regulated by the Securities Exchanges Act of 1934 Section 14a, federal proxy rules and, in some cases, state law. Federal proxy rules apply to the solicitation of all proxies of registered securities, but NOT to nonmanagement solicitation of 10 or fewer shs. The term «solicitation» is broadly interpreted by the SEC to include any part of a plan leading to a formal solicitation, e. g., inspection of shareholder list.

1) 1992 amendments--the SEC revised the proxy rules to make it easier for shs to communicate with each other. Significant changes include: a safe harbour for communications that don’t involve solicitation of voting authority, relaxation of requirements involving broadcast of published communications, relaxed preliminary filing requirements for solicitations, and removing communications between shs concerning proxy voting from definition of «solicitation.» 2) Requirement of Full Disclosure--the proxy rules require full and accurate disclosure of all pertinent facts and the identities of all proxy participants, disclosure of compensation paid to certain officers and dirs, and disclosure of conflict-of-interest transactions involving more than $ 60,000.