Basic Business Law (BPP432/80) Basic Business Law (BPP432/80) 2006 Fall Quarter2006 Fall Quarter

Instructor: David OliveiriInstructor: David Oliveiri

Week 11: Week 11: Facilitating Facilitating Exchange Through Business Exchange Through Business AssociationAssociation;; Corporations – Corporations –

Governance, Sarbanes-Oxley, Governance, Sarbanes-Oxley, Fundamental ChangesFundamental Changes

AgendaAgenda

Role of ShareholdersRole of Shareholders

Role of DirectorsRole of Directors

Role of OfficersRole of Officers

Duties of Directors and OfficersDuties of Directors and Officers

Sarbanes-Oxley ImpactsSarbanes-Oxley Impacts

Fundamental Changes of Fundamental Changes of CorporationsCorporations

Learning ObjectivesLearning Objectives

Understand Shareholder, Director, and Officer Understand Shareholder, Director, and Officer Relationships, and How Corporate Risk/Control Relationships, and How Corporate Risk/Control Bargaining Orders These RelationshipsBargaining Orders These Relationships

Understand the Elements of the Shareholder’s Understand the Elements of the Shareholder’s RoleRole

Understand the Elements of the Director’s and Understand the Elements of the Director’s and Officer’s Roles and Pertinent Distinctions Officer’s Roles and Pertinent Distinctions Between These RolesBetween These Roles

Understand the Legal Standards of Director and Understand the Legal Standards of Director and Officer PerformanceOfficer Performance

Understand What Sarbanes-Oxley Act Provides Understand What Sarbanes-Oxley Act Provides and How the Act Affects Director and Officer and How the Act Affects Director and Officer RolesRoles

Understand What are Fundamental Corporate Understand What are Fundamental Corporate Changes, Requiring Special ApprovalChanges, Requiring Special Approval

Corporate Governance, Corporate Governance, GenerallyGenerally

““New” Participants – Shareholders, New” Participants – Shareholders, Directors, OfficersDirectors, Officers

Primary Theme: Primary Theme: – Separation of Ownership and ControlSeparation of Ownership and Control– Broad Delegation (Shareholders Directors Broad Delegation (Shareholders Directors

Officers) of Day-to-Day OperationsOfficers) of Day-to-Day Operations

Agency Principles InterwovenAgency Principles Interwoven

Deal Point of Risk vs. Control Foremost in Deal Point of Risk vs. Control Foremost in Defining Relationships Among ParticipantsDefining Relationships Among Participants

Institutional Shareholder Services, Inc. – Institutional Shareholder Services, Inc. – Service Providing Corporate Governance Service Providing Corporate Governance Ratings That Correlate Various Governance Ratings That Correlate Various Governance Variables and Financial PerformanceVariables and Financial Performance

ShareholdersShareholders

Owners of Corporation Owners of Corporation

Residual or Equity InterestResidual or Equity Interest

Similar to Sole Proprietors, Similar to Sole Proprietors, Partners? Partners?

Role of Shareholders = f (VRole of Shareholders = f (VDD, ,

VVFCFC, P), P)

Shareholders’ Voting Rights – Shareholders’ Voting Rights – “One Share/One Vote”“One Share/One Vote”

Primary “Forum”Primary “Forum” – Annual (By-Laws) and Special – Annual (By-Laws) and Special Shareholder MeetingsShareholder Meetings

Meeting RequirementsMeeting Requirements -- Quorum (Majority Outstanding -- Quorum (Majority Outstanding Stock “Represented”) + Majority Vote -- Exception: Stock “Represented”) + Majority Vote -- Exception: Articles Articles

Election of DirectorsElection of Directors – Annual (Unless 9 or More), – Annual (Unless 9 or More), Straight Voting v. Cumulative VotingStraight Voting v. Cumulative Voting

Approval of Fundamental ChangesApproval of Fundamental Changes

Concentrations of Voting PowerConcentrations of Voting Power – Proxies, Voting Trusts, – Proxies, Voting Trusts, Shareholder Voting AgreementsShareholder Voting Agreements

Restrictions on Transfers of Shares Restrictions on Transfers of Shares – Note on Stock – Note on Stock CertificateCertificate

[S&R 36 – [S&R 36 – Problem 8]Problem 8]

Concentrations of Voting Concentrations of Voting PowerPower

Proxy Voting TrustShareholderAgreement

Definition Authorization of anagent to vote shares

Conferral of votingrights on trustee

Agreement amongshareholders onvoting of shares

Formalities Signed writingdelivered tocorporation

Signed writingdelivered tocorporation

Signed writing

Duration Eleven months,unless otherwiseagreed

Ten years; may beextended

No limit

Revocability Yes, unless coupledwith an interest

No Only by unanimousagreement

Prevalence Publicly held Publicly and closelyheld

Closely held

Shareholders’ Policing Shareholders’ Policing RightsRights

Right to Inspect Books and Records = f Right to Inspect Books and Records = f (Good Faith, Proper Purpose)(Good Faith, Proper Purpose)

Right to Sue to Enforce Shareholder RightsRight to Sue to Enforce Shareholder Rights– Direct SuitsDirect Suits– Derivative SuitsDerivative Suits

Right to Dissent to Fundamental Changes; Right to Dissent to Fundamental Changes; Appraisal and “Cash Out”Appraisal and “Cash Out”

Compaq Case (S&R p. 707) v. Compaq Case (S&R p. 707) v. Honeywell CaseHoneywell Case

Steve Case, co-founder of AOL and architect of the ill-fated Steve Case, co-founder of AOL and architect of the ill-fated AOL-Time Warner merger, resigned from TW’s Board in the AOL-Time Warner merger, resigned from TW’s Board in the face of the opposition of shareholders angered by the deal, face of the opposition of shareholders angered by the deal, which led to massive write-downs, shareholder lawsuits, which led to massive write-downs, shareholder lawsuits, regulatory scrutiny, and a management purge – Rochester regulatory scrutiny, and a management purge – Rochester D&C 11/1/05 D&C 11/1/05

Shareholder Suits: Direct Shareholder Suits: Direct SuitSuit

Direct Suit1. Compel payment of properly declared dividends2. Enforce right to inspect corporate records3. Protect preemptive rights4. Compel dissolution5. Enjoin an ultra vires act

Shareholder

Direct Suit

Corporation

Recovery

Personal Rights of Personal Rights of ShareholderShareholder

Shareholder Suits: Shareholder Suits: Derivative SuitDerivative Suit

Derivative Suit1. Recover damages from management for breach of duty2. Recover improper dividend3. Enjoin wrongful issuance of shares4. Recover damages from third party5. Recover damages from management for ultra vires act.

Shareholder

Derivative Suit

Third Party

CorporationRecovery

““On Behalf Of” Corp.; All SH On Behalf Of” Corp.; All SH BenefitBenefit

DirectorsDirectorsBasic Function: Delegated Power and Duty to Basic Function: Delegated Power and Duty to Manage the CorporationManage the Corporation

Not Strictly Agents of Shareholders or Not Strictly Agents of Shareholders or CorporationCorporation

But … Trustee-Like (Agent-Like) Fiduciary But … Trustee-Like (Agent-Like) Fiduciary DutiesDuties

Basic Directors’ Duties:Basic Directors’ Duties:– Determine By-LawsDetermine By-Laws– Select and Remove OfficersSelect and Remove Officers– Determine Capital StructureDetermine Capital Structure– Initiate Fundamental ChangesInitiate Fundamental Changes– Declare DividendsDeclare Dividends– Determine Management CompensationDetermine Management Compensation– +SOX Enhancements+SOX Enhancements

Directors 101Directors 101

Who Are They?Who Are They?– InsidersInsiders– Friends/AssociatesFriends/Associates– OutsidersOutsiders

How Do People Become Directors?How Do People Become Directors?– Number (NY -- 3 or More Unless…)Number (NY -- 3 or More Unless…)– Election (Articles 1Election (Articles 1stst SH Meeting Annually SH Meeting Annually

Unless Staggered)Unless Staggered)

How Do Directors Do Their Job?How Do Directors Do Their Job?– Collectively – In Meetings!!Collectively – In Meetings!!

Quorum and Voting Quorum and Voting Action Taken Without MeetingAction Taken Without Meeting

– Delegation of Powers Delegation of Powers – Directors’ Inspection RightsDirectors’ Inspection Rights– CompensationCompensation

[S&R 36 – [S&R 36 – Problem 2, 3]Problem 2, 3]

OfficersOfficers

Selection and Removal (“Exception”: Selection and Removal (“Exception”: Employment Contract)Employment Contract)

Role /Agents of the CorporationRole /Agents of the Corporation

Authority Set and Delegated by Directors Authority Set and Delegated by Directors (Via By-Law or Board Resolution)(Via By-Law or Board Resolution)

Authority Impacts = f (Actual Express Authority Impacts = f (Actual Express Authority [Articles, By-Laws, Board Authority [Articles, By-Laws, Board Resolution], Implied Authority, Apparent Resolution], Implied Authority, Apparent Authority, Ratification)Authority, Ratification)

Fiduciary Duties of Directors Fiduciary Duties of Directors and Officers and Officers ―― Standards of Standards of

Performance!!Performance!!ObedienceObedience

Diligence -- Diligence -- Review Quality of Decision Process Review Quality of Decision Process – Ordinary – Ordinary CareCare– Reliance Upon Others Permitted Reliance Upon Others Permitted – Business Judgment Rule – Immunizes Good Faith Decisions in Business Judgment Rule – Immunizes Good Faith Decisions in

Face of UncertaintyFace of Uncertainty

Loyalty – Loyalty – Review Fairness and Reasonableness of Specific Review Fairness and Reasonableness of Specific ActivitiesActivities – Conflict of Interest Conflict of Interest – Loans to DirectorsLoans to Directors– Corporate Opportunity [Broz]Corporate Opportunity [Broz]– Transactions in SharesTransactions in Shares– Duty Not to CompeteDuty Not to Compete

[S&R 36 – Problem 1][S&R 36 – Problem 1]

[S&R 36 – Problems [S&R 36 – Problems 5a, b]5a, b]

+SEC Standards – +SEC Standards – The SEC notified 3 high-profile current The SEC notified 3 high-profile current and former directors of Hollinger International Inc. that and former directors of Hollinger International Inc. that they may be sued for failing to spot fraud that senior execs they may be sued for failing to spot fraud that senior execs of the newspaper company are suspected of committing – of the newspaper company are suspected of committing – NY Times 12/15/05NY Times 12/15/05

Management Structure of Management Structure of Corporations: Corporations:

The Statutory ModelThe Statutory Model

ShareholdersElect and remove directors

Approve fundamental changesSmith & Roberson’s Business Law

Chapter 36

§

Board of DirectorsDeclare dividends

Delegate authority to officersManage the business of the corporation

Select, remove, and determine compensation of officers

OfficersRun the day-to-day

operations of the corporation

Management Structure of Management Structure of Typical Closely Held Typical Closely Held

CorporationCorporation

Shareholders = Directors = Officers

Relative Problems – Boards of Family Relative Problems – Boards of Family Businesses Grapple With How to Sack Businesses Grapple With How to Sack Executives Who Are Kin – WSJ 7/24/06Executives Who Are Kin – WSJ 7/24/06

Management Structure of Management Structure of Widely-Held Public Widely-Held Public

CorporationCorporationShareholders

Sign and return proxiesSell Shares

Board of DirectorsDelegate authority to officers

Ratify actions of officers

OfficersInfluence selection

of directorsRun day-to day

businessInfluence

proxyvotes

Sarbanes-Oxley Act Sarbanes-Oxley Act

An Act to protect investors by improving the accuracy and reliability of corporate disclosures

made pursuant to the securities laws, and for other purposes – 1/23/02

Sarbanes-Oxley Act (a.k.a. Public Sarbanes-Oxley Act (a.k.a. Public Company Accounting Reform and Company Accounting Reform and Investor Protection Act of 2002, Investor Protection Act of 2002,

SOX, SarbOx)SOX, SarbOx)Legislative Reaction to Corporate and Accounting Legislative Reaction to Corporate and Accounting Scandals (Enron, Tyco, WorldCom, …)Scandals (Enron, Tyco, WorldCom, …)

New and Enhanced Standards for U.S. Public New and Enhanced Standards for U.S. Public Companies, Boards, Management, and Public Companies, Boards, Management, and Public Accounting FirmsAccounting Firms

Requires the SEC to Implement RegulationsRequires the SEC to Implement Regulations

Specific Provisions:Specific Provisions:– Public Company Accounting Oversight BoardPublic Company Accounting Oversight Board– Auditor IndependenceAuditor Independence– Corporate ResponsibilityCorporate Responsibility– Enhanced Financial DisclosuresEnhanced Financial Disclosures– Enhanced White Collar Crime PenaltiesEnhanced White Collar Crime Penalties•Restatements of financial results by public companies soared in 2005, Restatements of financial results by public companies soared in 2005,

in part due to SOX – WSJ 3/3/06in part due to SOX – WSJ 3/3/06•Make SOX Fit – WSJ Editorial (Harvey L. Pitt, Former SEC Chairman) Make SOX Fit – WSJ Editorial (Harvey L. Pitt, Former SEC Chairman) 4/13/064/13/06

Fundamental Changes of Fundamental Changes of CorporationsCorporations

Economic Good Sense to Facilitate Fundamental Economic Good Sense to Facilitate Fundamental Changes Changes

But … Fundamental Changes Materially Impact But … Fundamental Changes Materially Impact Interests of Shareholders, Officers, and Interests of Shareholders, Officers, and DirectorsDirectors

So, …Legal Rules for Approval Balance Economic So, …Legal Rules for Approval Balance Economic Good Sense and Interests of StakeholdersGood Sense and Interests of Stakeholders

What Are Fundamental Changes? What Are Fundamental Changes? – Charter AmendmentsCharter Amendments– CombinationsCombinations– Dissolution/Going PrivateDissolution/Going Private

Rights of Dissenting ShareholdersRights of Dissenting Shareholders

Fundamental Changes***Fundamental Changes***Change Board of Director

Resolution RequiredShareholderApproval Required

Shareholders’Appraisal RemedyAvailable

A amends its articles ofincorporation

A: Yes A: Yes A: No, unless amendment materiallyand adversely affects rights of shares

B sells its assets in usualand regular course ofbusiness to A

B: Yes B: No B: No

B sells its assets not in usualand regular course ofbusiness to A

B: Yes B: Yes B: Yes

A voluntarily purchasesshares of B

A: YesB: No

A: NoB: No, individualshareholders decide

A: NoB: No

A acquires shares of Bthrough a compulsoryexchange

A: YesB: Yes

A: NoB: Yes

A: NoB: Yes

A and B merge A: YesB: Yes

A: YesB: Yes

A: YesB: Yes

A merges its 90 percentsubsidiary B into A

A: YesB: No

A: NoB: No

A: NoB: Yes

A and B consolidate A: YesB: Yes

A: YesB: Yes

A: YesB: Yes

A voluntarily dissolves A: Yes A: Yes A: Not usually

*** Under pre-1999 RMBCA

Bottom Lines; Q&ABottom Lines; Q&A

Separation Of Ownership And Management Separation Of Ownership And Management Characterizes Corporations – And Characterizes Corporations – And Minimizes Shareholder Transactions CostsMinimizes Shareholder Transactions Costs

Shareholders Have No Duties, Generally!Shareholders Have No Duties, Generally!

Broad Director and Officer Authority Is Broad Director and Officer Authority Is Bounded By Shareholder (+ Regulatory) Bounded By Shareholder (+ Regulatory) Oversight/Legal Standards Of PerformanceOversight/Legal Standards Of Performance

The Business Judgment Rule Immunizes The Business Judgment Rule Immunizes Good Faith Decisions; Application Is Fact-Good Faith Decisions; Application Is Fact-Based (i.e. Local)Based (i.e. Local)

Sarbanes-Oxley Enhances Legal Standards Sarbanes-Oxley Enhances Legal Standards Of Performance For Public Company Of Performance For Public Company Officers, Directors, Auditors, Lawyers Officers, Directors, Auditors, Lawyers