LS311 – Business Law I

1. LS311 – Business Law I Seminar Presentation UNIT 9 Business Organizations Chapter 26: Corporate Directors, Officer, & Shareholders Chapter 27: Investor Protection, Insider Trading, & Corporate Governance

2. Unit 9 • Three (3) items to complete in Unit 9. They are: • Unit 9 Written Assignment (40 points) • Unit 9 DB (20 points) • Unit 9 Case Study (20 points) • Let’s discuss Chapter 26

3. Chapter 26: Role of Directors & Officers Every corporation is governed by a board of directors. Individual directors are not agents of corporation, only the board itself can act as a “super-agent” and bind the corporation. A director can also be a shareholder, especially in closely-held corporations.

4. Election and Compensation of Directors • The number of directors is set forth in the articles of incorporation: • Directors are appointed at the first organizational meeting • In closely held companies, directors are generally the incorporators and/or the shareholders • Term of office is generally for one year • Director can be removed for cause • In very large companies, directors can be compensated, and may be officers as well.

5. Board of Directors’ Meetings • Directors hold meetings pursuant to bylaws with recorded minutes • Special meetings may be called with sufficient notice • Meetings require QUORUM (minimum number of directors to conduct official corporate business, usually majority) • Each director generally has one vote

6. Rights of Directors Directors have the right to: • Participate in corporate decisions and inspect corporate books and records • Compensation (usually a nominal sum) and indemnification. If a director is sued for acts as director, the corporation should guarantee reimbursement (indemnification) or purchase liability insurance to protect the board from personal liability

7. Corporate Officers and Executives • Officers serve at the pleasure of the Board of Directors but have fiduciary duties to company as well • Their employment relationships are generally governed by contract law and employment law • Officers may be terminated for cause

8. Duties and Liabilities of Directors and Officers • Fiduciaries of corporation - ethical & legal duties • Duty of Care • Act in good faith and in best interests of the corp.; • Make informed and reasonable decisions; and • Exercise reasonable supervision • Duty of Loyalty • No conflict of interest • No insider trading • A dissenting director is rarely held liable

9. Business Judgment Rule • Immunizes a director or officer from liability from consequences of a business decision that turned sour • Court will not require directors or officers to manage “in hindsight” • As long as decision was reasonable, informed, made in good faith and in the best interests of the corporation, BJR will apply

10. Role of Shareholders • Ownership of shares grants a shareholder an equitable ownership interest in a corporation. • Shareholders generally have no right to manage the daily affairs of the corporation, but do so indirectly by electing directors. • Shareholders are generally protected from personally liability by the corporate veil of limited liability.

11. Common shareholder - one vote per share Articles and bylaws can exclude or limit voting rights of certain classes of stock Quorum must be present Cumulative Voting allows minority shareholders to get a board member elected Shareholder Voting

12. Rights of Shareholders • To vote • To have a stock certificate • To purchase newly issued stock • To dividends, when declared by board • To inspect corporate records • To transfer shares, with some exceptions • To a proportionate share of corporate assets on dissolution • To file suit on behalf of corporation

13. Shareholder’s Derivative Suit • Shareholders can sue a 3rd party on behalf of the corporation if the Directors fail or refuse to correct the wrong or injury. • Directors may refuse to take action because they might personally be liable. • Any damages recovered go to corporation’s treasury.

14. Liabilities of Shareholders • Shareholders are generally not liable for the contracts or torts of the corporation. • If the corporation fails, shareholders cannot lose more than their investment, except when: • A shareholder hasn’t paid for stock pursuant to the stock subscription agreement. • Shareholder buys “watered stock” which is below the stock’s par value.

15. Chapter 27:The Securities Acts • In response to the stock market crash of 1929 and the Great Depression, Congress enacted two acts: • Securities Act of 1933 • Securities Exchange Act of 1934 • Apply to public companies • To structure and oversee the offering, selling, and trading of securities in ways that would protect investors

16. Securities Act of 1933 • Requires that investors receive information about securities offered for public sale • Prohibits fraud in the sale of securities by requiring that securities be registered • Registration includes information including • a description of properties and business, • a description of the security to be offered for sale, • information about management of the company, & • financial statements certified by independent accountants

17. Registration Process • Registration statement does not become effective until approval by SEC. • Pre-Filing Period: issuer cannot offer or sell securities. • Waiting Period: securities can be offered by not sold. 2005: Free-writing prospectus. • Post-Effective Period: registration effective 20 days after approval.

19. Violations of the 1933 Act • Intentional or negligent fraud of investors by misrepresenting or omitting material facts in the registration statement and/prospectus. • Defenses: Statement left out was not material; Plaintiff knew about fraud and purchased stock; Registrant believed statements were true. • Penalties: • Criminal: up to 5 years in prison and $10,000 fine. • Civil: damages, refund of investment, injunction.

20. Securities Exchange Act of 1934 • Created the Securities and Exchange Commission (SEC) • Power to register, regulate, and oversee brokerage firms, transfer agents, clearing agencies, and securities self-regulatory organizations • To give the investor confidence and prevent another collapse in the system

21. Section 10(b) and Rule 10b(5) • Section 10(b) prohibits the use of any manipulative or deceptive device or contrivance in contravention of rules and regulations of SEC. • Rule 10b(5) prohibits the commission of fraud in the connection with the purchase or sale of any security.

22. Insider Trading • Advance information available to corporate officers and directors that can affect future value of stock. • Insider information must be material • Must be a fiduciary relationship for liability

23. Insider Reporting and Trading—Section 16(b) • Section 16(b) • Recapture by corporation of profits during previous six months gained by insider trading. • Applies to stocks, warrants, options and convertible securities. • Proxy Statements, Section 14(a) • Whoever solicits a proxy must fully disclose all of the facts and which shareholders must vote.

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

25. Sarbanes-Oxley Act of 2002 • In response to the Enron fall in 2001, Congress enacted the Sarbanes-Oxley Act of 2002 (SOX). • To protect investors by improving the accuracy and reliability of corporate disclosures, • To enhance corporate responsibility, • To end corporate and accounting fraud, and • To restore the image of stock purchases as investments worth the risk. • Requires documented internal controls • Requires CEO and CFO certifications

26. Key Provisions: Sarb-Ox

27. Unit 9 Written Assignment Chapter 27 • Case Scenario: Dale Emerson served as the chief financial officer for Reliant Electric Company, a distributor of electricity serving portions of Montana and North Dakota. Reliant was in the final stages of planning a takeover of Dakota Gasworks, Inc. a natural gas distributor that operated solely within North Dakota. Emerson went on a weekend fishing trip with his uncle, Ernest Wallace. • Emerson mentioned to Wallace that he had been putting in a lot of extra hours at the office planning a takeover of Dakota Gasworks. On returning from the fishing trip, Wallace met with a broker from Chambers Investments and purchased $20,000 of Reliant stock. Three weeks later, Reliant made a tender offer to Dakota Gasworks stockholders and purchased 57% of Dakota Gasworks stock. Over the next two weeks, the price of Reliant stock rose 72% before leveling out. Wallace then sold his Reliant stock for a gross profit of $14,400.

28. Unit 9 Written AssignmentChapter 27 • For your Assignment answer the following questions: • Would registration with the SEC be required for Dakota Gasworks securities? • Did Emerson violate Section 10(b) of the Securities Exchange Act of 1934 and SEC Rule 10b-5? • What theory or theories might a court use to hold Wallace liable for insider trading? • Under the Sarbanes-Oxley Act of 2002, who would be required to certify the accuracy of financial statements filed with the SEC? • Note: Your assignment must be in APA format, include a title page, the paper itself (the discussion) and a reference page

29. Questions & Reminders • Questions on Unit 9 material? • Remember to complete all Assignments • Unit Self-Check Quiz (Not for a grade) • Discussion (See Discussion Board Posting Requirements) • Written Assignment • Case Analysis • Office Hours: Thursdays 7-9PM (ET) • Have a great week! • Good luck on the final!