ba outline 1

8/3/2019 BA Outline 1

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Theoretical justification for attributing an agents actions to a principal: control(he whoacts through another acts himself), benefit(those who benefit from actions of another

should be held to answer for costs of actions), and consent

Two Major Kinds of Authority: Actual and Apparent to bind principal1. Actual Authority: Rest. 3.01: created by a manifestation from the principal to the

agent that the principal consents to the agent taking actions on the principals behalf

y Two types of actual authority: Express (specifically set out-written or oral)and Implied (power to do things necessary to fulfill agency-facts will

determine)

y Castillo: Implied authority on part of ATC by Chicken farm to house andtransport workers as part of recruitment process-identity of official employer

is not determinative all that is needed is ingredients above.

2. Apparent authority (what third party reasonably believes based on actions ofpurported principal)

y Basics exists where a 3rd party reasonably believes, based uponMANIFESTAIONS by purported principal, that apparent agent is authorized

to act on behalf of the purported principal

oManifestation by the Principal is the key ingredienty Apparent Authority exists in 2 situations:

oPerson who appears to be an agent but really isntoAgents act beyond the scope of their actual authority

y Disclosed Principal: when an agent and a third party interact, the third partyhas notice that the agent is acting for a principal and has notice of the

principals identity

y Undisclosed Principal: when an agent and a third party interact, the thirdparty has no notice agent is acting for principal

y RequirementsoManifestation: a manifestation by principal that is received (directly

or indirectly) by third person, and scope of agents authority depends

on the third persons reasonable interpretation of that manifestation

y Examples of manifestation: Statements or actions from purported principal

indicating intent or consent

Placing apparent agent in a position where consent canbe inferred

Tradition and custom: prior dealings Acquiescence in limited circumstances

oWhat is NOT manifestation of apparent authority:


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y Unilateral acts of the agent (the main reason how apparentauthority is not)

oJustification: principal has ability to control their manifestations; canchoose to act in ways that dont show apparent authority of the

certain agent

y Scopeothe amount of authority allowed is only what is reasonablegiven the

manifestation made

oDoes not require reliancey Estoppel: Non-agency measure of authority that gets applied to remedy

detrimental reliance-principal that looks a lot like apparent authority

oRequires third party to change position in reliance on the principal,whereas a principal may be bound under apparent authority even in

absence of detrimental reliance

oAllows third party to hold principal liable but does not give theprincipal any rights against third party (only operates in one direction)

oRequires detrimental reliance [unlike apparent authority]y Inherent Authority (inherent in an agency relationship)

oWhen there is an undisclosed principal (beer case)oInherent agency is agency that exists not from actual, apparent, or

estoppel but from fairness principals and due to a benefit to the

principal-liability imposed as a matter of fairness

oNo consent, no control; ONLY BENEFIToRestatement 3d puts inherent authority under the realm of apparent

authority

y BethanyPharmaceutical: whether Janis has authority to acton part of QVC the actions on which Bethany relied and

purchased 100k worth of materials on that reliance-Holding:

Janis had no authority and no reliance

y Respondeat Superior(tort doctrine)oAn employer or master is held vicariously liable for the torts of its

employee or servant, committed within scope of employment (a P

must establish an employee/employer relationship existed (Ware:

nurse/doctor-must be voluntary and right of control)

oDifference between employees and independent contractorsy Employees will be treated as agents under this doctriney Independent contractors may or may not be treated as agents

depending on facts of the case and the jurisdiction


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oEmployee or independent contractor is determined based on facts ofthe case and degree of control

PARTNERSHIPS

Benefits: easy to form, flexible in organization, and favorable tax treatment (NO LL) RUPA and UPA: vehicles for standardization of partnership law (only tested on RUPA)-if a

partnership was formed before 1997 governed by UPA RUPA is mostly a set of default rules that can be changed, so only a few unwaiverables as set

out in 103

Partnership is generally governed by the partnership agreement Theortical question: Are partnerships aggregations or entities? RUPA says entities: that is

partnerships are separate legal entities with separate legal status from the individual partners-

Learned Hand supports entity theory

Formationo RUPA Definition: An association of two or more persons to carry on as co-owners of a

business for profit (202)

No formalities are required to form a partnership-all that is required is abovedefinition (no written agreement, no conscious intent, no knowledge that a legal

partnership is formed)

Can be formed by accidento Requisite Intent: Have to intend to work together as partner no conscious intent to enter

into legal partnership-Courts will look to certain indicia of intent, specifically profit sharing

RUPA presumes a partnership if there is profit sharingy Waugh: Although parties agreed that each side would bear its own losses,

they agreed to share profits and court found that the parties did have a

partnership

Court most likely to find in favor of a partnership in terms of third party liability Even if parties specifically disavow the existence of a partnership, the court may still

find a partnership (if it looks like a partnership)A disavowal is not dispositive

y Holmes: two friends decided to start Urban Decay Cosmetics but friend withall the money cut other friend out of co, and friend sued-court ruled that a

partnership had been formed but didnt look to agreement to share profits

but looked to things such as Lerners own statements, the fact that a person

would not work for a year for free,e ct. Oral agreements are enforceable-

securing of financing is good indicator of when an idea becomes a

partnership

Authority/Management-RUPA 301o Every partner is an agent of the partnership


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o (301) Both partners have actual and apparent authority over the partnership-any partnermay bind the partnership-Rogue partners can bind all partners if acting within scope of

usual duties

Lawson: holding all partners liable for actions of rogue partners-all partners can beheld liable bc each partner is an agent of the partnership

o Management: All partners have equal rights in the management and conduct of thepartnership business (equal say)-If partners disagree about ordinary matters within the

scope of the partnership business, the vote of the majority of partners controls (401)-

o Voting: RUPA 401 Each have equal unless specified otherwise by agreement Default requires majority Certain transactions require unanimity

y Amending agreementy Adding new partnersy Extraordinary transactions

Fiduciary Duties (404)o 2 Prongs of Fiduciary Duty

1. Duty of Loyaltyy Account for partnership property, hold it as trustee for the partnershipy No adverse dealingsy No Competition in partnership businessy Meinhard: duty of loyalty in a partnership is a moral duty-takes a very hard

line on loyalty-courts have since softened approach

2. Duty ofCare: Requires that partners avoid gross negligence, recklessness,intentional misconduct, and knowing violations of law

3. Phantom Prong: Duty of good faith and fair dealingo Conductthat furthers one partners interests is not a per se violation of fiduciary duty

o Gibbs: lawyers leave firm and take confidential info with them-case discusses thingsthat are and are not breaches of duty-balance of competing concerns of personal

interests v. partnership interests

o Partners may conduct business with partnership but cannot give self sweetheart dealo 404 partially waivable

Financial Attributes/Structure Partnership Accounting

Contribution: Each partner typically starts out with a contribution to the capital ofthe partnership and that money is credited to that partners capital account

Withdrawal: partners may take out funds of invested capital-charged to theiraccount


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Profits and losses are shared from normal operation (usually equally (401b) butdepends on agreement

Partners share (usually equally) in gains and losses from sale of partnership-sale ofproperty must be unanimous

Liability 306: All partners are liable jointly and severely for all obligations of the partnerships (joint

and several liability)-each partner on hook for 100% of actions of other partners

eck: Two relatively junior partners at a law firm are held personally liable foractions of another partner even though werent involved in fraud, did not know of

fraud, were not in charge, and had left the firm before partnership was sued-

withdrawing partners remain liable for matters pending at time of dissolution-

Unlimited Personal Liability-very serious

Ending the Partnership Definitions

Dissolution: event that triggers the process of winding up Winding Up: the process of ending the partnership (liquidation) Termination: partnership is over Dissociation: one or more partners leave but partnership usu. Remains

y Under RUPA, not all dissociations lead to dissolution (601-603)y Under 601, dissociation may rise from death, choice, bankruptcy, court

orders expulsion, agreement, ect.

y Under 602, a partner may dissociate at any time, rightfully or wrongfully, byexpress will

y Dissociation is wrongful only if: it breaches a provision of the partnershipagreement, or before end of partnership term or undertaking the partner

withdraws by will, is expelled by court or becomes bankrupt or legally

terminated-may trigger wind-up 801

y Article 7 governs by outs in cases of dissociation that do not lead todissolution-if dissociation does not lead to dissolution, then departing

partner must be bought out

y Liquidation Rights: process of converting assets to cash distributed topartners

o 801: liquidation on dissociation is default-Rationale: protectingdeparting partner-departing partner can force liquidation

o Each partner can pull plug and force liquidation unless causedwrongful dissociation (602)

o Expulsion: removing a partner w/out dissolving partnership


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An expelled partner has no liquidation rights (this raisesquestions about fid. Duties and concerns that others may

benefit unfairly from expulsion)

HYBRID ENTITIES Contain favorable attributes of both partnerships and corporations

Pa

r

tner

ships: easy to form, easily adaptable, favorable tax treatment (not taxed as entity,only as individual), BUT unlimited liability

Corporations: Harder to form, harder to adapt, harder to dissolve, less favorable taxation(double taxation, both corp. and shareholders taxed) BUT limited liability

LIMITED LIABILITY PARTNERSHIPS(LLP) Just like general partnerships without personal liability for partners not involved in

misconduct (LLP still liable and doesnt shield you from individual wrongdoing)

Requirements Two or more persons conducting business for profit Must register with state with brief description of purpose (Can never enter by

accident)

y Provide NOTICE to parties dealing with LLP ensuring that 3rd parties areAWARE that debts can only be satisfied from LLP assets, not individual

partners personally (who doesnt have notice? Unintended creditors)

Each individual liable for own mistakes and LLP also liable with each partnersliability limited to their investment-BUT no personal liability

Attributes: pass through taxation, simple formation, management and dissolution simple asopposed to corporate management structure

Dowv. Jones: An accused child molester sues lawyer and firm for malpractice after he isconvicted-Court denies firms motion for SJ bc although firm was dissolving at time lawyer

takes case and malpractice occurred, if had not completely wound up-partnership still on

hook

LIMITED PARTNERSHIPS(LP) One or more General Partners manage the day to day operation and affairs and may be

held personally liable while one or more Limited Partners provide some financial

contribution but do not manage anything and are not personally liable for partnership

Limited partners not liable for anything Must file something with state to form Control Rule: If a limited partner exercises some control over partnership then may

loose LL

Note: if a general partner is a corp. this can further insulate from liability bc securinglimited liability for all participants


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LIMITED LIABILITY LIMITED PARTNERSHIPS(LLLP) Registration required with state Limited partnership that applies LL to the general partner

LIMITED LIABILITYCOMPANIES(LLC) History: 1986Tax Reform Act Statute: LLC statutes have been adopted in all 50 states but vary greatly

Formation Pay the fee and file certification of organization (Articles ofIncorporation) with the

state containing relevant business info (check the box)

NOTICEis very important (must include certain things) Do not have to file operating agreement (describing how LLC operates) Only need one person Incredibly flexible Essentially a corp. that elects to be taxed like a partnership (no double taxation) Stone v. Jetmar: example of how cannot accidently form LLC-must complete all

formalities-LL requires formalities

Authority Managing members have both actual and apparent Non-managing members have no inherent authority Extraordinary measures require majority or unanimous consent

Management In general: centralized (like a corp/manager managed) v. decentralized (like a

partnership/member-managed)

y Default: member managed (decentralized like a partnership w/ each memberhaving equal management rights)

Representations to third parties-some or all LLC members will be agents Management is customizable but usually resembles partnerships

Gottsacker: must deal fairly Limited Liability

Basics: not liable for actions just bc one is member of LLC-member who createsharm or involved in illegal behavior can be held liable for bad acts and LLC itself IS

also liable-just limits liability to innocent members

Horton: not uncommon for people to set up multiple LLCs to avoid personal liability-case is essentially about one guy setting up multiple LLCs and folding one LLC in

order to get out of deal with another company trying to pierce the veil of the LLC to

try to get to main guy (can collect from LLC that is now bankrupt, but cannot collect

from member)-Borne not liable bc his use of the LL did was not the proximate cause


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of the harm-What is this rationale? To promote business; but if court finds fraud

then generally not hesitant to pierce

y Piercing the veil is a means of circumventing LL and holding personalshareholders liable for obligations of the corp. when s/h failed to treat corp.

as a separate legal entity (Court will look to two things: (1) was co. an alter

ego of s/h; (2) was there abuse such as fraud)

Social Costs of LL: Creates wealth transfer from tort creditors (involuntary creditors)to s/h doesnt force equity owners to bear losses

Benefits: allows for free flow of capital, diversification, risks Duty

In general, if LLC looks like a partnership then will have fiduciary duties like apartnership, if looks like a corp. then fid. duties like a corp

y In general, members owe duty to entity Delaware Statute: can expand, restrict, eliminate duties (can waive it all), but

cannot waive good faith and fair dealing-downside: people can breach all over the

place (Wild West)

y Why?: principal of freedom of K- should have put it in K Balancing Act: want to attract people to business but want to avoid people doing

bad things

Purcell: court finding basis for fiduciary duty even though contract sort of allowsparties to do whatever they like

Tzolis: should derivative suits be allowed in LLCs? YES (Derivative suits: actions inwhich shareholders sue on behalf of corp. to enforce duties of managers)

y It is essential for s/h to have recourse when those in control breach theirduty

Dissolution 2 Divergent views: (1) should resemble partnerships, or (2) should be a lock in

y The lock in view is favored by those who believe LLC members should havenegotiated exit rights in operating agreement

Valinote: court places importance on concept of LL-court applies operatingagreement as it reads and no indemnification for Valinote who surrendered his

interest to his partner

Haley: Court ultimately enforces a judicial dissolution bc of indisputable deadlockbw 50% owners and the exit mechanism in place was unreasonable so forced

dissolution bc more equitable

Note: LL may be vital to a companys ability to raise capital


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CORPORATIONS

Corporate governance is the set of rules and norms governing behavior of corporate actors-behavior shaped by legal rules and also market forces and human traits-trick is to construct a

system under which participants cooperate for mutual benefit

Corporations are among oldest LL form Corporations are separate legal entities from s/h

Players Officers: people who run the day to day operations of the corporation (presidents,

CEO, CFO, Treasurer, ect)

Directors: (MA 8)y Basics:

o Supervise officers and elected by the shareholders-act as a group(board of directors)

o Responsible for all fiduciary duties (Care, Loyalty, GF)o Must disclose to s/h for informed voteo Board of directors meets about 10 times a yearo Must be at least one, usu. threeo Every public corp. has to have a board

y Typeso Inside

Employed by the corporation (usu. CEO, CFO, generalcounsel)

Issue: there to supervise officers, but they are the officers(agency issues)

o Outside Not employed by corp., independent w/no ties to corp. other

than directorship role

Have fresh outlook but may not be as well informedy Elections

o Regular: default method boards usu elected at yearly s/h meetingso Staggered: allowed in MA and DE only if specified in charter or

bylaws (looks like senate) 803, 805, 806

Directors elected to multi

-

year terms where not every directorwill be up for vote at same time-lessens number of directors

up for election any given year

Is an anti-takeover device bc a majority of directors alwaysremain at one time

y How Directors Act


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o Voting: usu. requires a quorum-# of people required to hold a vote;default quorum under MA is a majority of the majority

o Actions on consent (no meeting just written consent of boardmembers)-valid by default

o How often they meet is in bylawso Committees: smaller delegations of directors; cant amend by laws,

cant fill vacancies on boards, cant authorize dividends

y Removalo Directors can resign or dont re-elect themo Remove w/ or w/o cause depending on what in chartero May be removed by court

Shareholders: (MA 7)owners of the corporation who have passive role in corp(VOTE, SELL, and SUE)

y Generally, one share of common stock=one votey Powers

o Voting: Annual s/h meeting-exercises the s/h control Fundamental issues get s/h vote

y Director electionsy Amending charter/bylawsy Mergers (depending on if target or acquiring or short

form)

y Sale of assets not in ordinary course of businessy Dissolutiony Ratification of conflict of interest

Typesy Straight (MA default)-a simple majority requirement

o Can change by putting in chartery Cumulative: multiply # of seats to voted on by # of

votes shareholder gets and those votes can be placed

as they choose (all on one seat if want to secure that

seat)

o can give minority a voice-pool votes on oneseat (increase minority participation on BD)

o more common in close corp.o staggered boards can defeat purpose

y By Proxy (7.22)-allowed by defaulto s/h appoints another to cast their voteo used mostly in public corp.


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o regulated by state (who gets a vote) and fed(how they do it)

o Raises issues of agency Quorum: must be a majority unless in director elections

which require plurality bc may never have majority so just

have to have most votes

o Meetings Regular: 7.01

y Usu. vote at annual meeting (pub corp. annual meetingis default)

y s/h may seek court order to set meeting date Special: 7.02(between annual meetings)

y Called by board or 10% shareholder-can be specified incharter/by laws

y Often called to try to replace directorsy This shifts power dynamic bw s/h and director

o Action by Consent: 7.04 Allows s/h to act w/o a meeting Requires unanimity so rarely happens-designed for close

corp so can make decisions more quickly

MA limits this to close corpo Amendments

By-Law Proposals: 10.20y S/h has power to change bylaws and is one of few

things they can initiate-cannot remove director powers

y Directors may initiate as well Charter: 10.30-s/h limited

y Only directors may initiatey IfS/h disagrees with directors then only way to amend

charter is to elect new board members on your side

2 basic types of corporationso PUBLIC: traded publicly with formal governanceo PRIVATE: closely held (not traded publicly, have to have permission to buy stock,

looser governance)

o Corporations can move from private to public Incorporation

o Basicsy Have to file Articles ofIncorporation with State (Charter)


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y Only need one person to incorporatey Cannot accidently enter into corp.

o MA 2.02y Articles must set forth:

o Name of corporation which identifies it as a corp (4.01)o Number of shares the corporation is authorized to issueo Name and Address of each incorporator and initial agent

y Can include: purpose (better to be broad), management provisions, by-laws,liability and indemnity, ect.

y Delaware requires purpose but MA does noty Charter and Bylaws: Articles ofIncorporation is called the Charter (public doc

putting everyone on notice); the Bylaws are the rules of internal operations

(private doc)

y Shareholders can amend bylaws but amending charter is complicated Capital Structure

o Equity and Debty Equity: $-power to control and receive fruits of business

o Stock: sold to shareholders so corp. gains capital/equity (6.01)-mustbe specific in charter-# authorized does not all need to be issued to

issue more then is in charter, charter must be amended

Two Typesy Common

o Gives right to residual assetso Gives right to voteo Must be at least one share of one class of

common stock

y Preferred (can create if put in charter)o Priority claim on co. assets and repayment if co.

goes under

o Stock gives ownership which gives right to assets upon liquidationo Stock terminology:

Shares are issuedwhen sold Shares owned by s/h are outstanding If repurchased by corp. they are treasury shares Par Value: sales price of shares: today par value of shares has

no relationship to price, it is not uncommon to set par value at

a penny so that al money raised in selling shares is available as

surplus


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Surplus: all capital in excess of the legal capital-distributionscan only be made out of surplus

GAAP: generally accepted accounting practicesy Debt: A fixed obligation of repayment independent of the success or failure

of the business

o Basics Operates through contract and is not set out in charter Advantages: generates capital w/o surrendering equity

control

Tax breaks Allows corp. to use equity elsewhere Risks: debt requires regular payment, and conflict bw s/h and

creditor-debt has priority in repayment

o Bonds Basics

y A promise to repay a specific sum at a definite time,with periodic payments of interest

y Rated by third parties, the lower the rating the higherthe interest (junk bonds=low rating)

y May be convertible into stocky Not tied to anything but co.

y Do you want to raise capital through debt or equity? There are pros andcons to both and most companies have combination of both-maintain more

control with debt but pros to equity as well

Dividendso In general, most familiar method of distributing money to shareholders-simply a

payment, usually in cash, from a corporation to its shareholders-timing and amount

of dividends are determined by the board of directors in their discretion

y 2 ways to make money by buying stock: dividends or capital appreciationy Companies dont have to pay dividendsy An alternative to distributing dividends to shareholders is through share

purchases

o Limitationsy Corporate statutes limit amount of distribution (debt first then equity)y 6.40(c): cannot issue dividends if cannot pay debt in regular course of

business, and dividends cannot put co. in red (assets are less then sum of

liabilities)

o (1)Equity Insolvency Test: no dist. if corp. would not be able to paydebt in regular course of business; or


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o (2)Balance Sheet Test: no dist. if would go into redy Shareholder is residual beneficiary of corp. assets

Limited Liability Theoryo Corporations are oldest LL formso Corporate actors are only liable to extent of their ownership (stock)o Benefits: Allows for greater diversification, permits better share transferability, and

reduces monitoring costs

o Costs: creates Enron type situations with people behaving in risky manner (bad risk)-creates transfer from tort creditors to shareholders

y Increases cost of debt and decreases cost of equityy Moral Hazard: corp. actors not forced to pay all costs of their actionsy Risk that carries a high reward is a good risk even if results in a loss

Veil Piercingo Amongst most controversial topics in corp. lawo Attempt by courts to balance benefits of LL with its costso Notwithstanding LL, in some instances courts will require shareholders to be

responsible for damages beyond amount of their investment

o Usually occurs in closed corps.o Piercing the veil is a remedy encompassed within a claimo Factors considered by court:

y Were formalities followed (court all over map on this but usually ifformalities are followed then shields corp.)

o Court will look to co-mingling, separate bank accounts, regularmeetings, records, ect.

y Fairness Concerns: 3rd party not on notice of corp. shield, s/h treating corp.funds as their own (co-mingling)

o Soerries: underage girl goes to club, gets drunk and gets in an accident and dies andgirls family wants to pierce the corporation to get to the owner directly-Court holds

that bc owner disregarded separateness of legal entities by comingling he should be

responsible (Criticism: harm not linked to whether or not pierce; shouldnt it be

based on seriousness of harm? Interesting theoretical questions-does it really

matter to person killed whether corporate formalities were followed)

y Court will look to whether D overextended use of corp. entity to commitfraud, defeat justice, or evade tort responsibility

y Social cost of LL tort victims are unintended creditors Reverse Veil Piercing

o Corp. responsible for acts of s/hy In Re Phillips

o Both types of piercing strive to achieve an equitable result


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Close Corporationso General: s/h in closed corp. often contract around statutory default rules. Control

allocated via highly tailored arrangements. The following are ways to modify

control:

y Shareholder Agreements: k among shareholderso Vote Pooling Agreement: 7.31

Agreement among minority s/h to all vote in one way-enforceable but have to sue after the fact

o Governance Agreements: 7.32(closed corps.) Customizing corporation-can include a number of things but

there are some limits such as agreements must be unanimous,

must be included in charter or bylaws, and limited to 10 yrs.

y Can get rid of board, permanent directors, distributionrules, ect.

o TransferRestrictions By default, shares are freely transferable but can set up

transfer restrictions (ex. keep shares in family, balance of

power concerns, comply with law)

Close corps use these to monitor control Located in Charter, bylaws or cite agreement Only valid reasonable (6.27) Most Common: both valid in MA jurisdiction

y Options/right of first refusal: s/h or corp must offer itto each other before all others

y Buy-Sell agreements: either corp. or shareholdersrequired to buy if given option

o Benefits: Certainty (determines fair price atneutral time) and Liquidity

o Determining Price ofBuy-Sells Fixed: must be updated constantly and

reflects current value of shares

Book Value: based on historical value,most popular

Appraisal: parties agree beforehandhow to appraise

Formula: complicatedy Prior Approvals and Prohibitions (look at

reasonableness)

y Armour: transfer restriction upheld (divorced couple)


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o Voting Trusts: 7.30 Definition: Legal title of shares is transferred from the s/h to

the voting trustee and trustee has exclusive control over

voting power of those shares but s/h retains financial interest

in shares

y More powerful then vote pooling bc no backing outy Limits

o Must be in writingo Must be filed with Corp.o Limited to 10 yrs.

y Issueso Concern that bad trustees will take advantage

of investors

o Created to avoid rules against irrevocableproxies, can be an anti-takeover device, and

prevent conflict of interest

y Warehime: only obligation of trustee is to use bestjudgment and good faith-dissent says there should be

absolute loyalty and no self dealing

o Classified Shares: 6.01 Primary purpose is to allocate control among various classes

of shareholders

The ways control may be allocated is infinite: giving a classveto power over all decisions, giving a class no voting power,

allowing a class to only vote on certain matters

MUSTBEINCHARTER Can tailor as much as want Can create conflict among classes of s/hs Benchmark: court refused to read k more broadly then what

was actually negotiated

o Cumulative Voting Each shareholder is entitled to cast a number of votes equal to

the product of the number of each s/hs shares x number of

directors to be elected

Unlike straight voting, s/h may cast all votes in favor of singledirector

Must opt-in 7.28 (must be provided for in Articles) Purpose: to increase minority participation on the board of

directors-under straight voting, holders of a majority of shares


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would be able to elect all directors, but under cumulative

voting, minority s/h may be able to elect one or more director

o Supermajority Requirements: 7.27 Something more then 50% needed to win Available in both public and private corps.

y Public: serves as an anti-takeover device bc harder foracquirer to gain needed %

y Private: may essentially give one or more voters vetopower without offending corp. norms

Must be specified in Charter DE: may adopt it or amend it w/ mere majority vote MA: requires supermajority to adopt or remove Negatives: may allow small parties to be holdouts or

obstructionist, increasing potential for deadlock

Masson:Court rejects requirement of supermajority to dobasicbusiness functions (is this right ruling?)

o Preemptive Rights (rare in public corp) Right to maintain ones level of ownership in corp.

y If more shares are issued by corp. s/h has right topurchase their percentage to maintain their voting

power

o Ex. IF a s/h owns 10% of corp.s shares, apreemptive right would entitle them to

purchase 10% of subsequent issuance of shares

May be granted or denied in Articles default rule is againstpreemptive rights-MA provides for an opt-in to preemptive

rights

Purpose: protect against dilution of interest (Angel investorsare concerned about this)

Kimberlin: ex. of angel investor who negotiated preemptiverights for himself but then entered into a waiver provision that

said that the preemptive rights can be blocked with enough

votes-Court says waiver is valid

o Deadlock Occurs when s/h vote is evenly divided and difference cannot

be resolved

Usu. arise from failure to allocate control in advance butoccasionally business planners intentionally provide

opportunities for deadlock


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y Rationale: some business relationships should notproceed w/o unanimous consent to action

May occur at s/h or director level Usu. leads to dissolution: decision to dissolve typically

requires s/h and director approval but if cant agree to dissolve

then can be judicially dissolved

Courts occasionally turn to buyouts, provisional directors, orarbitration

Conklin: couple forms corp. and relationship falls apart andneither keeps records and end up suing each other and court

dissolves corp. and neither party gets anything

Minority Shareholderso Oppression

y Usu. occurs in closed corps. bc NO market for s/hs shares so might getfrozen out (shares in closed corps. known as illiquid)

o Classic Oppression Scenario: a maj. s/h terminates min s/hsemployment (in closed corps. s/h become employees to avoid double

taxation and make money) and refuses to declare dividends thus

cutting min. s/h off from financial benefits of his equity investment

and when try to sell, there is no public market so they are stuck

y This can lead to departures from fair dealing and frustration of rsbl.expectations of s/h both in voting rights and dividend payments

y Approaches (Delaware v.Mass.)o DE: BuyerBeware

does not give substantive protection unless bargained for relies on min. s/h ability to protect themselves (vote, sell,

sue)-S/h should have bargained for protection

Minority shareholders most vulnerable in DEo Mass.: Utmost good faith and loyalty-heightened duty

In closely helds, maj. s/h owes duty similar to a partnership Leslie: Freeze-out w/ no legitimate business purpose is not

allowed (crazy employee who was a director, officer and s/h

of co. was being forced out by other directors and court said

could not destroy value of his shares bc he was a s/h and so

owed utmost loyalty and GF

Cannot dilute min s/h equity ownershipo Protection

y Tools to Avoid Oppression


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o S/h agreements, Supermajority requirements, voting trusts,cumulative voting, buy-sell agreement

y Two MajorRemedieso Forced Buyout (14.34): preferred/most common remedy for

oppression

s/h may purchase shares of those seeking dissolution must be fair value Problem: maj. may not always be able to afford buyout Kirakides: one brother making unilateral decisions regarding

co. and offers brother very cheap buyout and court steps in

saying that offer was oppressive and unfairly prejudicial to

min. s/h (textbook freeze-out situation)-Court forces a fair

buyout-could have avoided with buy-sell provision

o Judicial Dissolution (14.30) Grounds for dissolution

y Deadlocky Illegal or oppressive activityy s/h prohibited from electing D for 2 yrsy corp. assets missaplied or wasted

o Other options of court: appoint custodian or provisional director,altering bylaws or charter, selling property, paying dividends or

damages

Court is pretty free to decide remedy-do what it sees best(Naito: can have decisions when taken individually would not

amount to oppression but when taken together do-Court

does not dissolve co. bc it is successful so orders payment of

dividends and babysits co.)-culture clashes

ShareholderVoting and Proxy Processo Voting Theory/Management Theory

y SEPARATION OF OWNERSHIP AND CONTROLo S/Hs own the company but board of directors run the show-s/h have

little control over corp. decisions

o s/h power is almost entirely reactiveo Accountability/Responsibility through law

Given this allocation of power it is essential that managers beheld accountable but also given freedom to take risks

(Balance)

y Centralized Authority (good and bad)


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o Benefits: essential if want to get anything done-streamliningdecision-making (impossible to involve every s/h in every decision;

directors have expertise)

o Disadvantages: ensuring that management acts in s/h best interestand not in own self-interest

y Level ofSupervisiono Voting rights in public corps. exist at intersection of state corporate

law and federal securities law

y AccountabilityMechanismso Disclosure Requirements (Fed. Securities Law and state law)

SUNLIGHTISTHEBEST DISINFECTANTo Fiduciary dutieso Takeoverso Market forceso s/h elections and director removal

y Basics ofVoting: Most voting happens by proxyo Proxy: authorizing someone else to vote on your behalfo Occurs at intersection of state and federal law

State sets which s/h can vote and on what Fed regulates the voting procedures

y Proxy Processo Governed by Federal Regulations (33 Act and 34 Act)o Both required mandatory disclosure of full and accurate information

Securities Act of1934y Broad: regulates secondary market transactions and

stock exchanges-acts of brokers and dealers

y Creates power in SEC to regulate corp. actionso Proxy solicitationso Tender offerso Purchase and sale of significant assets

o Proxy Solicitations Section 14(a) of34 Act: applies to shareholder

communications known as proxy solicitations (competing

packets of info.)

y Corps. usu send out proxy statements saying what isbeing voted on and what choices are

y Usu. management seeks s/h voting right through proxyy Who wins proxy fight usu. wins vote


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y Barbash: not always clear what types ofcommunications are considered proxy solicitations:

this case involved advertisements in newspaper-court

reads rule broadly as any solicitation reasonably

calculated to influence s/h vote? Look at nature of

communication and circumstances in which it was

made

Disclosure Requirementsy Once a communication is identified as a proxy

solicitation, Rules 14a-3 to 14a-15 apply, requiring

party engaging in proxy solicitation to send proxy

statement with specified information to s/h being

solicited

y These rules regulate info that must be provided to s/h,format for actual proxy card, format for presentation

of info.

o Shareholder Proposals (14a-8) s/h has power to require co. to include proposals and

resolutions fin co.s proxy statement for action at annual s/h

meeting

this is one of few proactive powers that s/hs exercise in publiccorp.-move towards more and more power for shareholders

Two Typesy Social Activist Proposals

o Asking BD to study or disclose sociallyirresponsible behavior-usually brought by

members ofSocially Responsible Investment

Funds

y Corporate Governance Proposalso Seeking changes in co.s bylaws to do away with

poison pills, remove officers or directors, and

other corporate governance issues-usu.

brought by institutional investment community

like pension funds

Rule 14a-8y Major battleground for s/h proposals is whether s/h

can force co. under this rule to include their proposal

in proxy statement (s/h group can mail out


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independently but this is not practical bc extremely

expensive)

y Requirementso A s/h must proponent must own at least $2,000

worth of stock or 1% of outstanding shares for

at least 1yr prior to submitting proposal

o Proposal must reach co. 120 days before dateof co.s proxy statement is to be sent giving co.

time to include proposal or seek a No-Action

Letterfrom the SEC (basically says that SEC

wont sue co. for not including prop-does not

ensure that Ps wont sue or wont be sued

elsewhere

y Corporate Grounds to Excludeo Proposals that are impropero Props that are irrelevant

Exception: sign. Public policy issueso Props that relate to ordinary business functionso Props that relate to elections (AFSCME)

y Apache: apache properly excluded proposal bc dealtwith ordinary business functions and too much an

attempt to micromanage

Bylaw Amendmentsy Difficult to get passedy Boards and shareholders often at odds and boards can

often just ignore s/h (Gillete)

y Bebchuck: to what extent can s/h change by laws? Director Nominations

Director Dutieso Business Judgment Rule

y Rational business judgments of boards will be respected-strong presumptionin favor of board decisions

y Presumption that business decisions will not be questioned(like a safe harborprovision)

y Ps can rebut the presumption by showing that directors breached a duty ofloyalty or duty of care, or acted in bad faith

y At that point, the directors bear the burden of showing that the transactionmeets the standard ofentire fairness

o 2 Prongs (Duty ofCare and Duty of Loyalty)


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y Duty ofCare (8.30)o Exists but courts follow common law

Director must act in good faith (post Stone GF is part ofloyalty)

Standard is that directors and officers must behave asreasonably prudent person would have under circum.

o Imposes a duty but there is no liability attached so risk is minimal dueto BJR-usu. only breached w/recklessness or gross negligence

o Basically, rule insolates board and officers (safeharbor)o Benefits: Rule encourages directors to take risks which is in interest

of s/h and encourages people to become directors

o Basic Structure ofRuley (1) Presumption in favor of Directors, (2)Ps can rebut by showing breach of

fiduciary duty (loyalty or care, or bad faith), (3)Directors must show

transaction meets standard ofEntire Fairness (fair dealing + fair price), (4)

the directors can show they had insurance, indemnification, or exculpation,

(5)then plaintiffs can try to show waste (but never win on waste)

y Gargliardi: (steak-ums case) central teaching of this case is that courts willnot second guess the decisions of the directors unless the process that

generated those decisions is unsound

o Poor business judgments do not create breacheso Disjunction bw risk and reward: corp. directors of public corps usu.

have small ownership interest in corp. and little incentive

compensation so if they could be held liable for every risk that failed,

then would not take risks or become directors-that is there is a BJR

y The circumstances under which courts will become suspicious of boarddecisions falls into two categories

o (1)Conflicts of interesto (2) gross negligence when failing to gatherrequisite info.

Must gather at least a reasonable amount of info. Can be satisfied by a minimal inquiry

y Van Gorkom: (Duty ofCare breach)the 2 hour, no homework decision ofboard to recommend merger with number ($55) pulled out of thin air was

NOT an informed decision and NOT protected by BJR

o Board must inform themselves ofall information reasonablyavailable to them and relevant to their decision-here, even though

price was good, board did not take steps to inform themselves/did

not ask questions


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o Also must disclose all material information such as a reas. s/h wouldconsider important when deciding whether to approve offer

o Board must rationally believe decision is in corp.s best interesto Oversight (8.31)

y An exception to BJR-asleep at the wheel e.g. Van Gorkomy Part of Duty ofCare is duty to provide oversight

o Directormustbereasonablyinformedaboutwhatishappening incorp.

y Breach can arise from sustained and systematic failure to be informed-eesviolate law and director had no idea and co. forced to pay judgment or

penalities

o Francis: (figurehead of corp)widow of cos founder pain no attentionto co allowing her sons to embezzle funds from co. and s/h sought to

recover money from widow and the theory that her neglect caused

their loss-Court imposed duty of oversight on widow and stated that

directors have to engage in very simply activities such as: min. duties

include: attend corp. meeting, read financial statements, ask

questions, ect.

o Caremark: very influential case-co. had no oversight mechanisms inplace and allowed illegal activities to occur opening them up to

liability-Court said that boards have obligation to assure themselves

that information and reporting systems exist to satisfy obligation of

being reasonably informed

Not terribly onerous standard Just has to be a way for board to get information to satisfy

oversight requirements

o Wastey Even ifEF is satisfied and still inside BJR, there still may be liability if court

finds co. committed waste

y Definitiono Decision wasso egregiousthatno businessperson wouldhavemade

same decision (no rationalbasis forthe decision)

y Often comes up in context of executive compensation (excessive salaries)y Very hard to prove, rarely if ever successful-Court will not find waste as long

as co. asserts some reason for decision

y So in theory waste exists but Court never finds boards liable for wasteo Insurance and Indemnification

y Insurance


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o Nearly every co. has insurance to protect directors against violationsof duty of care

o Co. insures against personal liability for directors actions (likemalpractice insurance)

o Can cover loss for directors decisions where indemnification noavailable

o Limits Cannot insure intentional misconduct No insurance for dishonesty No insurance for breach of duty of loyalty

y Indemnification (8.51-8.57)o Generally, if a co. is liable then may K to indemnify them (cover their

liability)

o Can be established by bylaw or chartero Court can order it upon petition of directoro Limited under state statutes under agency theoryo Goal: to entice top directors to join co. and encourage business (take

risk to yield high results)

o Exculpationy Director can K out of duty of care if put in charter (K out of liability)y MA 2.02: can exculpate anything except: robbing co., intentional violations

of law, or intentionally harming co.

y Exculpatory clauses protect directors against monetary liability and not otherdamages (injunctions)

y Cannot exculpate duty of loyaltyy Risk:

o Shareholder Primacyy S/h are primary beneficiaries of duty of carey In US there is idea ofshareholder capitalism where overriding goal of co. is

to maximizeshareholderwealth beyond producing needed goods and

services

o In Europe, corps consider such things as employees interests(preserving jobs) and interests of community

yDirectors are required to make decisions in best interest of corp.

Courts

have often concluded that s/h are primary beneficiaries of duty of care

(Dodge v. Ford)

o Can say that actions will be in long term interest of s/h Kahn v. Sullivan: art museum case where corporation

spending millions on new art museum-business judgment rule


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court agrees with companys decision and agrees with the

boards argument that there will be long term benefits of such

an investment

o So, when making a decision, even if for moral reasons, must say thatit is in s/h financial interest

y Think Marriot problem: overriding goal is to maximize s/h wealth-protectedby BJR when making decisions based on other considerations such as

corporate image and generating good will (just say that it is our business

judgment) building bottom line

o Good Faithy Disney: Post-Disney still not resolved whether an independent cause of

action can be brought for a breach of duty of good faith-Court also does not

clearly define what is good faith but points to DE 3 prong test for bad faith

(deliberate inaction, conscious dereliction, and intentional disregard), but

says could be other things as well

y Stone: completely rearranges what fiduciary duty means-Court says thatessentially Disney and Caremark involve same claims and all those claims are

duty of loyalty claims

o Duty of good faith and duty of care=duty of loyaltyo Duty of good faith=3 prong test + anything elseo Court adopts Caremark and Disney as good law but reclassifies them

as Duty of Loyalty cases

o So, now NO independent duty of care or good faith ONLY duty ofloyalty

y Lyondell: tightens definition of good faith following Disney but duty of GFcases are still loyalty cases after Stone

o Def:If did not knowinglydisregardresponsibilities, then did notviolate duty of good faith

o Duty of Loyaltyy No protection ofBJR-burden immediately shifts to party to show EF

o As of now, still considering Duty of Loyalty claims as independentclaims

o Any time there is a conflict of interest, duty of loyalty is implicatedo Requires directors and controlling shareholders to serve the interests

of the corp. over their self-interest

Tension bw cutting out bad and keeping good conflicts ofinterest bc of complication of divided loyalties, and non-

problematic transactions

y Self-Dealing/Conflicts of Interest


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o Cannotactin own self-interestoverinterestofs/ho Key players (directors/controlling s/h) usu. successful business people

with many competing interests which may overlap with interests of

corp. (is there a conflict?)

o Look for following:(Hollinger) Key player is on both sides of the transaction Key player helped influence decision to enter transaction and

have something to gain

Key players personal financial interests are at least potentiallyin conflict with interests of corp.

Using confidential info. to benefit selfo If self-dealing then EF standard (unless freshening)

y Controlling Shareholders (Kahn v. Lynch)o 2 Prong Test (Williamson)

Owns more than 50% of the voting power in a corp.; or Exercises control over the business and affairs of the corp.

(coercive leverage)

o Where a controlling s/h stands on both sides of a transaction it will beviewed under EF standard as opposed to more deferential BJR-cannot

act in own self interest if a controlling s/h-must act in best interest of

co.

o Shifts burden back to BJR if freshening, if not must show EFo Bc in theory, freshening doesnt matter if controlling s/h can vote

whole board out

y Freshening and Other Protections (8.61, 8.62, 8.63)o Main way to protect against bad conflicts of interest is to get non-

interested people involved to make decisions

o So, must be fully informed, disclosed, and approved voteofindependent/disinterested parties (have people benefiting not vote)

o key players can protect selves by using freshening measuresy Corporate Opportunity

o Key Players cannot divert financial opportunity for their own personalgain (cannot be in direct competition with corp.)

o Plaintiff must prove that opportunity was corporate opportunity Three tests in Common Law

y Interest or expectancyo Precludes acquisition by corporate officers of

property of a business in which that business

has a legal or equitable interest


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y Line ofBusinesso When a managing officer becomes involved in

an activity intimately associated with the

existing or prospective activities of the corp

y Fairnesso What is fair and equitable under circumstances

o Defense: disclosure of opportunity and intention to pursue itfollowed by consent

o Not one factor is dispositive-courts looks at many thingso Can avoid with freshening (Broz)-then in safeharbor-so justshould

have formallypresented itto co. andstepped outofroom

Mergers and Acquisitionso MergerBasics

y There is a market for corporate control (idea underlying mergers):underperforming corps. will be fixed by market forces and in best interest of

market bc s/h get more money-if believe in approach then believe law should

get out of away

y Two Types ofMergers (Friendly and Hostile)o Friendly

Predominate in the market for corporate control (50 to 1) Occur with consent of target co. board

o Hostile Resistance of management

o Three Basic Ways to Structure an acquisitiony (1)Merger orConsolidation (MA 11)-can only be friendly-Merger: surviving

co. is one of two co.s in transaction-Consolidation: two co.s form new co.

(target co. shs get vote)-mergers good for target co. s/hs

o Triangular: created to save time (only target s/h vote on sale tosubsidiary)

Acquiring co. creates and funds a wholly owned subsidiarythat holds merger consideration (cash, stock, bond, or

combo.)-Selling co/target merges into the subsidiary, thus

there is no need for parent co.s s/h to vote, only target s/h

vote-Then subsidiary merges back with parent

o Short-Form (only time target s/h do not get to vote) Voting rights of target co. can be eliminated If a parent co. owns 90% of subsidiary, they can merge the sub

into the parent by buying out min shares-this is called a Cash

Out


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Shareholders can trigger an appraisal if price unfairy (2) Purchased of assets and liabilities (MA 12)-can only be friendly

o What assets and liabilities transfer and remain with seller can benegotiated by K

o Successor liability can be imposed by statute 14.07o Formalities: both boards adopt resolution to purchase/sello AcquirerOR target s/h get to vote if20% change in stock price

y (3) Purchase ofStock-friendly or hostileo Acquirer gains maj, or all of targets stock (control) by offering a

premium (Tender Offer) to s/h of target, who then sell-this requires

no board approval or s/h vote-if individual s/hs want to sell they can

(buy directly from s/h)

o Self-tender: a co. can purchase up its own stock, once it has 90% maydo short form merger/cash-out

If they dont get 90%, can persuade board to adopt mergerbut this may trigger s/h vote

If s/h with voting rights are unhappy with sale price, cantrigger an appraisal

o Acquirer s/hs dont get a vote unless going to dilute shares by 20%o Defending Hostile Takeovers

y Poison Pillso Most powerful defense to hostile takeoverso Limits ability of potential acquirer to purchase shares by given s/h

rights to purchase shares at a deep discount if any bidder acquires a

certain percentage of shares w/o boards approval

This dilutes the acquirers shares preventing them fromgaining control

The existing directors have right to dissolve pill giving themleverage to negotiate a better price from acquirer

o Getting around the pill Enter into a friendly deal and get board to dissolve pill Proxy Fight: bidder tries to get a new board elected that will

diffuse pill and let bidder takeover

y Staggered board can still block you herey Poison Pill + Staggered Boards

o Particularly effective when used in conjunction bc will effectivelydefend against a proxy fight because cannot replace entire board at

one time when it is staggered (powerful anit-takeover device)


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y Dead Hand Pills: (illegal)-only people who can remove pill are directors whoput it in motion

y No-Hand Pills: (illegal)-on a timer and nobody can remove ity Restraints on Pills

o Duty to shareholders of getting best price v. entrenchmento Takeovers in General

yAcquirer wishes to acquirer target

-

if target agrees then friendly merger-

iftarget does not agree then hostile

y Acquirer can then seek to acquire enough shares through a tender offery Target then responds with a poison pill-if target reaches threshold then

shares diluted

y Then, at point ofnegotiation where target can try to negotiate favorableterms with acquirer and acquirer can still seek to evade defenses with a

proxy fight allowing acquirer to appoint new board members who can

redeem the pill

yTarget can then establish a stagge

red boa

rd which will mean at least 2

elections until board can be controlled by acquirer

y Cant avoid takeover forever-This adds the all important time factor to theprocess allowing time for a white knight to be located acquirer to loose

interest, time for market conditions to change, and time for acquirers

financing to fall apart

o Fiduciary Dutiesy Entire Fairness: When there has been a breach of duty of loyalty in a

takeover transaction there is no protection ofBJR and court will engage in EF

Analysis (Weinberger:no safe-harbor for divided loyalty in takeover

transaction)

o Fair Price (substantive): major factor considered by courts Can prove with finance reports, appraisals, committee

recommendations/approval, ibankers, market, ect.

o Fair Dealing (procedure): goes to disclosurey Freshening: if freshen (set up independent committees, ect) and a

controlling s/h then stay in EF and burden shifts to Ps to show unfairness; if

no freshening then burden stays on D (Kahn v. Lynch)

yAny analysis is extremely fact based and specific to situation

o Response to Takeovers/TakeoverSituationsy Intermediate Scrutiny

o In between BJR and EFo Applied to actions of board when faced with hostile takeover-was the

boards defensive measure fair w/in business discretion?


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o First Ask, if what the board seeking to do authorized? No-done deal and analyze under BJR/care/loyalty/ect. (board

tried to initiate dead-hand or no hand pill, or board initiates

own counter tender offer they cannot fund)

Yes-Apply Unocal 2 Part Test (court worried aboutentrenchment)

o (1)reasonably believes threat exists (consulted ibankersand ind. Directors or green mailer)

o Almost always satisfiedo (2)response was reasonable and proportionate to

perceived threat (court balances factors a co. will consider

when responding)

o Teeth of the Unocal Test (proportionality)o So, in theory must first apply Intermediate

Scrutiny and then do a BJR analysis, but if

passes 2 part test then automatically passes BJR

bc higher standard

Quickturn:(if notaction notauthorizethen no intermediatescrutiny)example of court not even getting to Intermediate

scrutiny bc co. introduced both a slow hand and dead hand pil

which is not allowed bc would not allow incoming board to

fulfill its fiduciary duties to co. bc hands were tied by pills-

court simply says that a board cannot limit its own duties and

that such actions are fundamentally wrong-board also cannot

delegate its duties to shareholders

o Additions to Intermediate Scrutiny Unitrin: when responding to threat, cannot be

y COERCIVE(forcing a management decision on s/h); ory PRECLUSIVE(cannot favor one bidder over another if

not in best interest of s/h-granting exclusivity rights to

one co. w/out including a fiduciary out-cannot tie

hands as a board member

o Omnicare: example of a co. failing the Unocal 2part test bc actions were not reasonable, and

court also found their response to be coercive

and preclusive-co. left themselves no way to

back out of a deal w/ one co. that wasnt in

best interest of s/h (cannot abdicate fiduciary

duties)


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o Even if not coercive or preclusive must bewithin range ofreasonableness

o When fail intermediate scrutiny directors mustshow EF

Revlon (Revlon Duties)y Changes Unocal standard again and introduces Revlon

Duties to the standard

y When breakup of co. becomes inevitable, the role ofdirectors changes from defenders to auctioneers and

when deciding to sell cannot look to any other factors

then getting the maximum price(best value

reasonably available to s/h)

y When is a breakup inevitable?o Active biddingo Change in long term planso Apparent co. will be broken

Timey Time weakens Revlon standard and says that a

breakup must be absolutely inevitable to trigger

Revlon Duties

o (1) there must be an active auction and (2) itmust be apparent that co. will be broken up or

co. abandons long term strategy

y Time says that a co. can take such things as co. cultureinto consideration when perceiving and responding to

a threat so not just looking for maximum pricewhen

breakup notinevitable

QVCy Court goes back to heightened Revlon standard and

says that when there is a CHANGE OF CONTROL (new

controlling s/h) a co. the Revlon Duties attach and co.

must seek highest price and cannot take such things as

protecting co. culture into consideration

y So, when moving from public to private must seekhighest price and nothing else

SECURITIES

Two Main Securities Acts (33 Act and 34 Act)o Both almost entirely based on disclosure (SUNLIGHT ISTHEBEST DISINFECTANT)


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o Both rely heavily on idea that the market will regulate itselfand neither involve muchsubstantive review

o Major Difference 33 Act: requires disclosures as very specific times (when a co. issues new stock, ect.) 34 Act: requires periodic disclosures (every year, every quarter, ect.)

o Fraud 34 Act governs fraud Anti Fraud Measures (section 10b and Rule 10b-5)-Prohibition against deceptive

practices

y Both rules operate as a package to prevent fraudy Basically cannot commit fraud either through active misstatements or

through omissions

y Section 10b-5 provides elements of cause of actiono Misstatements/Omissions

Misstatements: clear cut-false statements or assertions Omissions: half-truth or misleading statements when there is

a duty to speak (such as during periodic disclosures); absent

periodic disclosures no duty to speak, but if do speak then

must do so truthfully (so once start to speak cannot make

false statements of leave out facts)

y Gallagher: omissions of co. didnt create liability bcco. did not have a duty to continuously disclose and so

absent period of disclosure, co. had no duty to disclose

new information on own accord

o Materiality Substantial likelihood that a reasonable investor would

consider fact important in total mix of information about the

co.

y Standard is extremely fact and context specific Future Projections/Speculation

y Speculations can be material must look at:o Probability x magnitude(Basicv. Levinson)o If probability of event happening is high, and

magnitude of potential impact is high then

likely a need to disclose-no precise calculation

o Reliance Basicv. Levinson: completely changed rule on reliance

y There is a rebuttable presumption of reliance (FRAUDON THEMARKET)


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o Bc of difficulty in determining what exactly anindividual investor actually relied on, this case

creates a presumption of reliance that can be

rebutted by D

o This shortcut to reliance only comes up whenthere is an open market and price is

determined based on available info. (no pink

sheets bc market is illiquid)

o Theory is tied to idea ofEFFICIENTCAPITALMARKETS

Idea of efficient capital markets is basedon idea that it was statements that

made prices go up or down and so ok to

rely on statements

Critics of this theory say that thisdoesnt take into account inefficient

markets (think today) that dont rely

just on what people say (think stock

prices going down after good press, ect)

o Without new presumption, class actions wouldbe impossible bc each individual would have to

prove reliance

o Also, allows actions to be brought as classactions which is necessary bc cant have a bunch

of single actions worth $100 for example

o Scienter Intent to deceive-have to show something more then just

negligence on part of speaker-have to show some intent to

deceive or manipulate

y Tellabs: Ps required to state facts providing a StrongInference of scienter in pleading

o Strong Inference: more then merely plausibleor reasonable, has to be cogent and compelling

or no discovery

o Fact based analysis-Ps have to put togetherfacts and tell a compelling story in order to get

passed pleading stage

o Both sides engaged in story-tellingo This creates a tuff pleading burden for Ps


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o Causation Have to show that something actually occurred that caused

the harm

Two Types ofCausationy Transactional

o Requires P to allege and ultimately prove thatthe misstatement or omission caused P to

engage in the transaction in first place

(wouldnt be in the mess if had not relied)

y Losso But for the lies, P would not have bough stock

and lost money-P must allege and prove that

financial loss was caused by misstatement or

omission

In a capital markets transaction, thiselement is met by showing that the

stock price dropped after true facts

about co. emerged

y Dura Pharm: 2 steps of causation-court held that Pspleading was inadequate bc have to tell story in

pleading describing how stock prices went up bc of lies

and then stock went down when truth emerged-have

to connect the dots

o InsiderTrading Two Theories (Classical and Misappropriation)

y Classical Theory (10b and 10b-5)o When a corporate insider trades in the securities of his corp. on the

basis of material, nonpublic info. Violates as a deceptive device under

10b

Must disclose or abstain: an insider with knowledge ofmaterial nonpublic info. is prohibited from trading in co.s

stock

o TexasGulfSulphur: source of duty to disclose or abstain is thefiduciary duty that insiders, as agents of the co., owe to the

shareholders as principals-specifically targets trading by people inside

the firm (officers, directors, and employees)

o Smith: court says that soft information can be materialy Misappropriation Theory

o What is the duty of an outsider?


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Chiarella: SC says that there is no fraud by an outsider bc hadno duty to disclose bc no relationship creating fiduciary duties

(no fraud absent a duty to speak)

y SEC hates this ruling and thinks law should change andshould be based on integrity of the markets (everyone

owes a duty to the market)

OHagan: situation so egregious that SC finds liability but stillrefuses to hold that outsiders owe some broad duty to the

market

y Courts holding (very strange): If (1) you owe a duty tosomeone, somewhere and (2) receive non-public info.

that use to harm someone, somewhere else, then can

add two things together and get liability

o Combine breach to one person and harm toanother and get misappropriation (duty +

harm)

o Case involved lawyer who used info. he gotworking for his co. to harm another co. and

court imposed liability

o Patches a hole in the law but is theoreticallyugly

Tipper/Tippee: if any violates a duty then both liabley Tippee is liable if tipper had a duty

Sarbanes-Oxley

Prior to 2002, conventional wisdom was that regulation among directors, managers, and s/h wasmatter of state law and federal securities law only had minor role to play

System of corporate governance broke down (accounting firms, I banks, law firms, stock analysts,government regulators)

With fall ofEnron and World Com, policymakers seized opportunity to enact major legislativereform

Enron-accounting fraudy taking debt off own sheets and placing it on to other businesses (Fausto magic act) off

market sheet accounting off balance sheet debt

y Buying things from self and counting it as money iny Market to market accountingy Bribed ibankersy Most of what Enron did was legal at the time (besides the insider trading, ect.) but it all

came crashing down-is there an effective way to stop these things?


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SOX (much more federal involvement in corporate governance)o Public Company Accounting Oversight Board: provides oversight of accounting industryo Auditor Independence: outside, independent auditorso Audit Committees:o CEOCertification: CEOs and CFOs must certify accuracy of cos financial statementso CEO reimbursemento Code ofEthicso Conflict ofInterest Transactions: co cannot lend money to officerso Real Time Disclosureo Lawyers Responsibilitieso Whistleblower Protectiono Enhanced Criminal Penalties

SOX: Criticized as too expensive for business ownerso Hasnt really overhauled the system just filled in some holeso Ultimately ineffective in preventing todays crisis

ba outline 1

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