Piercing corporate veil - fiduciary duties – insider trading – formation – control – shareholder

derivative action
1. CORPORATIONS
i. Management- not held by the owners
1. The only right to manage that the owners have is to vote on who gets to
manage (these are the shareholders)
2. The managers are the officers and board of directors
ii. Taxation
1. Corporations pay taxes on any profit that they make and then they pass it
on the shareholders, then the shareholders pay tax on it
2. Shareholders do NOT have a right to share in profits
3. WHEN THEY DO SHARE the managers (board of directors) can declare a
dividend
a. The profit then gets shared with owners
b. But, this takes away from possibility of reinvestment in the
company
b. Corporate Entity and Its Formation and Structure
i. Fiduciary Duties
1. A promoter owes a fiduciary duty to the corporation
2. Corporation comes into existence the moment the secretary’s office signs it
3. Articles of Incorporation must include only:
a. Name- must be original and not confusingly similar to
another
i. Must include some form of “incorporated”
b. Authorized shares
i. Must state the max number of shares that the corp is
authed to issue
c. Registered agent
i. Must name authorized agent and address of its
registered office
ii. ONLY RESPONSIBILITY is to accept statutory
summons
d. Incorporators
i. Must state the name and address of each
incorporator
 4. To amend Articles of Incorporation (K between shareholders)
a. Board of directors must recommend
b. Shareholder must approve
c. Amendment must be filed
i. Once it’s received, then the shareholders are bound by new
agreements
ii. HOW TO INCORPORATE:
1. Once you file, you are entitled to limited liability
2. The real laws of a corporation are the by laws
a. These are how corporations run
b. IPOs-
i. Corporations offer shares of stocks under primary market to
certain individuals
ii. Monkey see, monkey do- goldman sachs is buying into it,
others will see and think that’s the thing that you do
c. What happens when one person has all the majority of the shares
and can then elect all persons to the board of directors- who do they
owe its allegiance to?
i. The Board’s fiduciary duties is to all shareholders
ii. must act on behalf of everyone
iii. Boilermakers Local 154 v. Chevron
1. Stockholders with the power to vote may appeal/adopt by laws
2. Board may adopt by laws if it pleases IF granted by the articles of
incorporation
c. The Role and Purposes of Corporation
i. A.P. Smith v. Barlow
1. We’re not going to stop corps from donating just to make stockholders
happy
ii. Dodge v. Ford
1. Ultra vires- outside of one’s power or authority
a. Intra vires- inside one’s power or authority
2. It is in the directors’ discretion to either do or not do dividends
3. A board of directors cannot make the affairs of the corporation for the
incidental benefit of shareholders and for the primary purpose of
benefiting others
 4. You can be good to the world if you also act in the interest of the
shareholders
5. There has to be some nexus between the corporate interest and
the charitable giving- in other words, the corporate interest is to
make money for the shareholders and what you choose to
support must support your corporate interest somehow
iii. Shlensky v. Wrigley
a. However, he tied it to a corporate purpose because he said the
neighbors wouldn’t like the lights and so they wouldn’t come to the
games
b. The Court recognizes that part of the corporate purpose is getting
along with the people around you- which includes publicity, etc.
c. The court says if you make an informed decision, we are
not business men and we do not know what’s best for your
corp- so if you have done your due diligence and
investigated and gotten information and then deliberated
about it- then we are not going to question or interfere
with that decision
d. First step- is it ultra vires (is the action outside the
corporate purpose)?
2. Court is without authority to substitute that of the directors if it’s within
the law- basically, unless fraud, illegality or conflict of interest
2. The Corporate Entity and Limited Liability
a. PIERCING THE CORPORATE VEIL
i. Alter ego- we can’t figure out where the corporation begins and the person ends-
it’s like they’re the same thing
1. Unity of interest
a. Enterprise liability- just because we organized our business in a way
to reduce our liability and also because we share a building does not
mean that we are responsible for each other.
b. This is sideways piercing and it’s the third situation in which to
pierce the corporate veil
c. IS. THERE. FRAUD. OR. INJUSTICE (tortfeasor)
i. Commingling of assets
ii. Undercapitalization- never enough by itself
iii. The use by one corporation by assets of another
iv. Lack of corporate formalities
2. When parent subsidiary
 a. Same board
b. Employees
c. Office
d. Tax returns
e. Same building
ii. The situation is such that not doing so would sanction fraud or promote injustice
1. Merely owing people money does not sanction fraud
b. “pierce the corporate veil”- you can’t see the individual owners so you can’t get to them
i. Generally must have some kind of intent to defraud or cheat
ii. Inequity alone is not enough- must be some act
iii. “unjust enrichment” is not just “I can’t pay my bills” but this is a precondition
c. Walkovszky v. Carlton
i. Enterprise theory- you’re in business together so you’re responsible for the debts
of the other
1. The Court said that does not make you liable on your own even though
sharing all resources
2. Just because you don’t have enough assets and can’t pay your bills, that
does not pierce the corporate veil
ii. The courts will distinguish between people who have contractual agreements
with corporation, and people who have been victims of tort from the corporation
when determining piercing the corporate veil
iii. The courts will “pierce the corporate veil” whenever necessary to prevent fraud
iv. When anyone uses control of the corporation to further his own rather than the
corporation’s business, he will be liable for the corporation’s acts upon the
principle of respondeat superior
v. One situation- each corporation is a fragment of a larger corporate entity
1. The corporate entity would be held financially responsible
vi. Second situation- the corporation is a dummy to protect the stockholder’s from
liability
1. If acting in his personal capacity, he will be held personally liable
vii. There different doctrines:
1. Enterprise liability
2. Respondeat superior *agency
3. Disregard of the corporate entity (piercing the corporate veil)
d. Sea-Land Services, Inc. v. Pepper Source
i. Court used the corporate veil
1. Must have unity of interest and fraud
2. A corporate entity will be disregarded and the veil of the limited liability
pierced when two requirements are met: First, there must be such unity of
interest and ownership that the separate personalities of the corp. and the
individual no longer exist; and second, circumstances must be such that
adherence to the fiction of separate corporate existence would sanction a
fraud or promote injustice- four factors:
a. The failure to maintain adequate corporate records or to comply
with corporate formalities
b. The commingling of funds or assets
c. Undercapitalization and
d. One corporation treating the assets of another corporation as its
own
3. Must also have intent
4. Where such an injustice would result and there is such unity of interest
between the corporation and the individual shareholders that the separate
personalities no longer exist, the corporate veil must be pierced
5. Unjust enrichment can be enough for the injustice to occur
a. Unity of interest reasons can be used to prove injustice
i. Common legal department
ii. Same officers
iii. Same employees
iv. Joint bank account
v. Joint accountant
vi. Did the parent organize the subsidiary and substantially
underorganize it?
e. Silicon Breast Implants
i. A parent corporation owns all (or substantially all) stock of another, subsidiary
corporation
ii. Courts are much more likely to pierce the corporate veil when the owner is
another corporation
iii. The parent is not liable for the debts of the subsidiary
iv. Limited liability is the rule, not the exception
 v. Totality of the circumstances- whether a subsidiary may be found to be the alter
ego or mere instrumentality of the parent corporation
1. The parent and the subsidiary have common directors of officers
2. The parent and the subsidiary have common business departments
3. The parent and the subsidiary file consolidated financial statements and
tax returns
4. The parent finances the subsidiary
5. The parent caused the incorporation of the subsidiary
6. The subsidiary operates with grossly inadequate capital
7. The parent pays the salaries and other expenses of the subsidiary
8. The subsidiary receives no business except that given to it by the parent
9. The parent uses the subsidiary’s property as its own
10. The daily operation of the two corporations are not kept separate
11. The subsidiary does not observe the basic corporate formalities, such as
keeping separate books and records and holding shareholder and board
meetings
f. Frigidaire v. Union
i. Difficult to distinguish between behavior as partners or behavior as between
people
ii. If these activities get mixed, you set yourself up for piercing the corporate veil
iii. Limited partners do not incur general liability for the limited partnership’s
obligations simply because they are officers, directors, or shareholders or the
corporate general partner
iv. If a corporate general partner is inadequately capitalized the rights of a creditor
are adequately protected under the “piercing-the-corporate veil”
3. Duties of Officers, Directors, and other Insiders
a. Fiduciary duties are imposed whenever you act on someone else’s behalf
b. Obligations of Control: Duty of Care
i. Kamin v. AMEX
1. Courts will not interfere unless the powers have been illegally or
unconscientiously executed, or unless it be made to appear that the acts
were fraudulent or collusive, and destructive of the rights of the
stockholders
2. Must prove that the directors have acted or are about to act in bad faith
and for a dishonest purpose
3. More than imprudence or mistake of judgement must be shown
 4. Court will not interfere unless a clear case is made out of fraud,
oppression, arbitrary action, or breach of trust
5. Business judgement rule has both a procedural and substantive aspect
a. If the procedural aspect is done correctly, it never gets to
substantive
i. Dumb and lazy- did you inform yourself
1. Informed to the point that a reasonable business man
would want to know under the same or similar
circumstances
ii. Did you deliberate?
1. a $300 laptop is hugely different than the $10 mil
business deal when deciding what to do
iii. If these two are met, we never get to substantive part- the
business guys did their due diligence and the court does not
have to talk about the decision any more
b. Substantive:
i. The actual substance of the decision
6. As long as process is done correctly, it doesn’t matter what the outcome of
the decision is, as long as they deliberated and were informed
ii. Smith v. Van Gorkom- very important case
1. A presumption that the directors acted in good faith and in the honest
belief that the action taken was in the best interests of the company
2. Were the directors informed when it came to the merger?
a. Whether the directors reached an informed business judgement
b. If they did not, whether the directors’ actions taken after were
adequate to cure any infirmity in their action taken
c. “interested director” that kind of director is one who would benefit
and the other directors would not
d. Must get some benefit that is not shared by other shareholders in
order to be an interested director
iii. The business judgement rule is a “powerful presumption” against judicial
interference
1. A shareholder challenging a board decision has the burden at the outset to
rebut the rule’s presumption
2. To rebut the rule, a shareholder assumes the burden of providing evidence
that directors breached any of the triads of their fiduciary duty:
a. Good faith
 b. Loyalty or
c. Due care
3. If the shareholder cannot, then business judgment rule applies
c. Business judgement rule only applies to the duty of care
i. Francis v. United Jersey Bank
1. What’s the scope of the duty of care?
a. Must be grossly negligent or intentionally uninformed
b. You have to ask and reasonably inform yourself
c. A director can never rely on their ignorance
2. Generally, directors have immunity and are not insurers of corporate
activities
3. A director should acquire at least a rudimentary understanding of the
business of the corporation
4. Requires a general monitoring of affairs and policies
5. Directors are immune if in good faith they rely upon the opinion of counsel
for the corporation or upon written reports setting forth financial data that
are done by a professional
4. Duty of Loyalty
a. Not protected by the business judgement rule
b. The duty of loyalty implicates greed- that means that the person benefitting from the
greed WOULD be informed and deliberate
c. CORPORATE OPPORTUNITY:
i. Is it in the realm of opportunity in which corporation would be
interested
ii. Bayer v. Beran
1. Burden of proof on the Board to prove the transaction is fair
2. Was the benefit to the corporation enough to justify the burden?
iii. Benihana of Tokyo, Inc. v. Benihanna
1. Common stock- no guarantees attached to it- no guarantee of a dividend
2. Preferred stock- authorized in articles of incorporation- these stockholders
have particular rights- almost always guarantees a dividend
a. They stand in line to get paid after general creditors
3. If the board is fully informed about a conflict, then the duty of care will
protect that decision
 4. Second question- did the interested party vote or influence the decision?
5. Duty of loyalty violation does not occur when there’s an interested
transaction with a board member IF the benefited board member does not
vote and if the board was informed
6. An interested party should never vote and generally leave the room during
deliberations
iv. Broz v. CIS
1. Corporate opportunities- falls under breach of the duty of loyalty
2. The shareholder has the burden of proof
a. Duty of loyalty- did you usurp a corporate opportunity- did the
board know?
i. Must demonstrate that the corporations is financially able to
take opportunity
ii. In corporation’s line of business
iii. By taking the opportunity, would the board member be
acting in his own self interest?
iv. Corporation must have an expectancy in the opportunity
v. Shareholder derivative action- Plaintiff would have to prove
all these things- shareholder
b. Duty of Care
i. All of this is true, but the board denies and says no
ii. Did they use business judgment rule?
5. Dominant Shareholders
a. Sinclair Oil Corp. v. Levien
i. A controlling shareholder must prove intrinsic fairness whenever a conflict of
interest exists.
ii. duty of loyalty concern
1. Taking excessive dividends
2. The dominant shareholder must prove fairness- intrinsic fairness
iii. Must meet intrinsic fairness test
1. High degree of fairness
2. Shift in burden of proof
3. Parent owes a subsidiary a fiduciary duty
4. Intrinsic fairness (super fair, much more than just being fair)
 5. standard only imposed when parent is acting in self dealing- both sides of
the transaction
6. parent can’t hurt the subsidiary by taking a benefit- both must get benefit
6. Ratification
a. Meets business judgment rule (fully informed board can make a decision
about whether a decision can be ratified)
i. Must be not dominated by any shareholder
ii. Or tainted by that board member that introduces it
iii. If board is disinterested
b. Fliegler v. Lawrence
i. Shareholder ratification of an interested transaction, although less than
unanimous, shifts the burden of proving fairness by reason of shareholder
ratification of the Board’s decision to exercise the option
ii. These shareholders are interested when they sell to Agau
1. Interested shareholders cannot be involved in the voting process
2. Not a disinterested vote by the Board
3. To not violate the duty of loyalty, everyone involved needs to know all of
the details with the transaction AND that intrinsically fair
4. If the majority of disinterested shareholders ratifies the transaction, it is
NOT a violation of duty of loyalty as long as those shareholders are fully
informed
5. OVERWHELMING PROOF OF FAIRNESS
iii. There’s no disinterested ratification WHEN:
1. There is not a majority of disinterested shareholders that
vote/vote for it
a. Interested shareholder’s votes get thrown out
b. Or if the board is entirely interested and doesn’t ask the
shareholders, they must show intrinsic fairness
2. The Board made no attempt to have the shareholders ratify
3. Disinterested ratification- board has burden of proof
iv. Summary of Duty of loyalty: complete candor of shareholders is
expected
7. Proxy Fights
a. Spending to get proxies:
i. What is a reasonable expense to get a quorum?
 ii. Is it related to the corporate proxy?
iii. Only reasonable and proper expenses can be reimbursed
iv. Fair and reasonable- voted on by the board- ratified by disinterested
shareholders
v. Incumbents ALWAYS get reimbursed because they have the duty to send out the
information to the Board
vi. The Insurgents DO NOT have a duty to the board so they must have disinterested
shareholder approval to get their costs back
b. Strategic Use of Proxies
i. Levin v. MGM Inc
1. A court can’t decide for the stock holders
2. The right of an independent stockholder to be fully informed is of supreme
importance
3. The controlling question is whether illegal or unfair means of
communication are being employed
c. Insurgents only get reimbursed if they win, expenses fair and reasonable, and board has
to vote on it and then it must be ratified by disinterested shareholder
d. Reimbursement of Costs
i. Rosenfeld v. Fairchild Engine
1. When the directors act in good faith in a contest over policy, they have the
right to incur reasonable and proper expense for solicitation of proxies and
in defense of their corporate policies
2. In a contest over policy, as compared to a power contest, corporate
directors have the right to make reasonable and proper expenditures from
the corporate treasury for the purpose of persuading the stockholders of
the correctness of their position and soliciting their support for policies
which the directors believe in good faith are in the best interests of the
corporation
ii. Proxy fights aren’t illegal but they are limited
8. Shareholder Proposals
a. NOT BINDING, just influential
b. Lovenheim v. Iroquois Brands
i. SEC RULE: shareholder proposals less than 5% OR not significantly related to
firm’s business, then it can be excluded from the proxy mail out
ii. “Otherwise significantly related” could mean social or ethical significance.
iii. If any security holder of an issuer notifies the issuer of his intention to present a
proposal for action at a forthcoming meeting of the issuer’s security holders, the
 issuer shall set forth the proposal in its proxy statement and identify it in its form
of proxy and provide means by which security holders
iv. “significantly related” is not limited to the 5% of revenue/asset test alone
c. AFSCME v. AIG
i. If the shareholders vote on it, it is binding
ii. SEC- no shareholder proposal could relate to an election
iii. Can a shareholder proposal that requires candidates nominated by the
shareholders on the ballots admissible?
iv. A shareholder proposal does not relate to an election under the SEC’s rules for
exclusion from a proxy statement if it seeks to amend the corporate bylaws to
establish a procedure by which certain shareholders are entitled to include.
1. Shareholder proposal that required corporation to include certain
shareholded minated candidates for board of directors on corporate ballot
could not be excluded from corporate proxy materials on basis that
proposal “relates to an election,”
d. Shareholder list- guarded at all costs
i. The SEC favors keeping them private except for specific reasons
ii. The incumbents don’t want insurgents getting the list and taking power of the
company
iii. SEC wants to avoid hostile takeovers
iv. Must be a shareholder to get the list
v. A shareholder must prove a proper purpose germane to interest of stockholder to
inspect corporate ledger
vi. You also have to be a stockholder at time of conflict
vii. NOBO lists- shareholders who do not object to being named
viii. The SEC requires production of a NOBO list upon request
ix. Even though the stockholder acts on behalf of someone who does not qualify to
request the list, they can still request it
x. Proxies maintain or obtain control of the board- that’s how they’re
used
xi. Shareholders do NOT owe fiduciary duties to corporation
xii. BOD and officers have fiduciary duties
xiii. General rule: if something doesn’t exist or information isn’t compiled,
you do NOT have to create something for you just because you want it
xiv. The court decided that there is a duty to provide the list to
shareholders and it was not had to generate- it was simple
9. Shareholder Voting Control
a. This considers state law with regards to the right or privilege to voting
i. The right to vote is important because of power to control
ii. Someone or some people have to be involved with deciding what the business is
going to be and all the details
iii. Promoters v. directors that have different functions, but want to set up so that
one party can maintain control
b. Stroh v. Blackhawk Holding
i. In order to be a shareholder, you just have to receive some right- and they have
that, with their right to control
ii. Shareholders have voting control in proportion to their stocks owned
iii. Owning stock does not require you to have an economic benefit, could just have
the right to control
10. Abuse of Control
a. Wilkes v. Springside Nursing Home
i. They wanted to freeze him out by telling him that he would not get a salary and
he was banned from the nursing home
ii. This is still a fiduciary relationship
1. They have fiduciary duties to each other and the three violated those
duties by freezing him out
2. The majority must prove that they had a business purpose for their action.
3. He did nothing that the other three could point to that caused a problem
with the business
4. Strictest of duties to the other shareholders
5. Could the business purpose have been achieved by NOT freezing out the
minority?
iii. When minority stockholders in a close corporation bring suit against the majority
alleging a breach of the strict good faith duty owed to them by the majority, we
must carefully analyze the action taken by the controlling stockholders in the
individual case
iv. Is there a legitimate business purpose for this action?
v. If it is, P must show that it could have been achieved by more restrictive means?
11. Control in Closely Held Corporations
a. These are no different than corporations we have been talking about
i. Sell agreements- you can only sell to other members
 ii. NO SEC- NO TRADING
iii. YOU HAVE A FIDUCIARY DUTY TO EACH OTHER
iv. YOU HAVE THE RIGHT TO MANAGE WHEN YOU BUY ANOTHER’S
INTEREST
v. The person who is coming in has a right to manage, so you want to be able to
control who comes in and out
vi. It is not inherent- you cannot limit who comes in JUST BECAUSE it is a closely
held corporation
vii. OWNERS DERIVE ALL INCOME FROM CLOSELY HELD (main purpose is
profit)
viii. CUMULATIVE VOTING RIGHTS TO ELECT THE BOARD
ix. When you set one up, though, you can set that agreement
12. Shareholder Derivative Actions
a. Direct claims- directly impacts the shareholders’ rights- something that relates to your
ownership of YOUR shares (the shareholder brings the suit; its rights are directly
impacted)
b. Derivative- a shareholder claims that the BoD is not doing their job in not asserting a
claim on behalf of the corporation
c. You have to be a shareholder at the time of the complained action AND ALL the way
through the action you are complaining about
d. Based on the corporations rights but brought by the shareholder
e. Must be pleaded with particularity
f. Intro
i. Cohen v. Beneficial Industrial Loan Corp
1. State where you’re from = substantive
2. State where you sue = Procedural
g. The Requirement of Demand on other Directors
i. The general rule is that a demand is required- but there is a futility exception
ii. You have to pick one or the other- if they reject the demand, you can’t then go to
prove futility. If you don’t make a demand and they show that it wasn’t futile to
do so
1. If it’s rejected, the court will analyze the rejection on the business
judgement rule
a. Independence and good faith of the committee who made the
decision- proven by the Board
 i. The committee is Board members who are not employees
who are indy of the action that the shareholder is bringing
b. Must exercise business judgment rule- Board burden of
proof
c. Futility- plaintiff has to prove
i. Are you dominated by/related to/are yourself the interested
party?
ii. Independence of board
d. The court can add its own indy analysis to decide whether
or not the demand should have been dismissed
2. Futility must prove that there’s interested shareholders
a. particularity
iii. Grimes v. Donald
1. When is a demand required and what’s the result of the refusal of a
demand?
a. If a demand is made and rejected by the Board, you can still sue but
you have to prove that it’s a wrongful rejection by Business
Judgment Rule (what they did to consider the rejection and how
they deliberated).
b. Must have an uninterested Board and it complied with the Business
Judgment Rule
c. Board must prove compliance with Business Judgment Rule
d. Plaintiff has burden to prove futility- by saying that the Board
entirely or just the majority of the Board is interested
e. Could also prove that they didn’t use BJR in the transaction you’re
complaining about- if you can prove that then you can prove futility
f. Either of these are dismissed with prejudice. You have to pick either
providing demand or proving futility.
g. If demand is made and rejected, was it a valid exercise of BJR to
refuse demand?
h. Instead, if shareholder doesn’t make demand, and claims futility,
the shareholder must prove that the majority of the board has
personal or familial connection with claim or majority of board is
dominated by a shareholder, or the result of the underlying claim
being brought with the BJR.
i. If Court determines that the demand is NOT futile, then demand is
not excused then you’re done
iv. Marx v. Ackers
 1. One claim- the BoD voted a raise for themselves, so this is an interested
transaction, so demand is excused
2. Second claim- three raises specifically for three board members because
three is not a majority- demand was not futile
3. A director will always be an interested party, for the purpose of the excusal
of a demand, when the director is voting on director compensation, but a
plaintiff has to demonstrate with particularity that the compensation is
excessive.
h. Role of Special Committees
i. Auerbach v. Bennett
1. The special committee looked into personal profits from the voting, they
turned in this whole thing to the SEC, then they had a committee to decide
on whether or not to let the litigation to continue
2. They had auditors and lawyers on board helping them
3. There were bribes that violated Federal law, and the Committee admitted
that
4. A party may challenge the independence of a special committee, but once a
committee is deemed to be independent then their decisions are protected
under the business judgment rule.
5. Special committees kinda took out the need for derivative litigation
because it took out the power from the P and the court because it keeps the
litigation in house- it’s a disinterested board of people that exercise BJR
for corporation
ii. Zapata corp. v. Maldonado
1. Here the Court said that we are not going to let special committees make
the decision alone- the court must now review and determine if it believes
that ending the litigation is the right thing to do.
2. A stockholder cannot be permitted to invade the discretionary field
committed to the judgment of the directors and sue in the corporations’
behalf when the managing body refuses
3. A demand, when required and refused, terminates a stockholder’s legal
ability to initiate a derivative action
4. The court applied a two-step test to determine if the Committee should be
permitted to dismiss the litigation.
a. First, Defendant corporation has the burden to prove that the
Committee is independent and is exercising good faith and
reasonable investigation.
b. Second, the court should apply their independent business
judgment.
 5. Where demand is properly excused, shareholder can commence on corp.’s
behalf
iii. In Re Oracle Corp. Derivative Lawsuit
1. Two complaints: the trading defendants breached their duty of loyalty by
misappropriating inside information and using it as the basis for trading
decisions and the other defendants who didn’t trade but are members of
the board, a Caremark violation because the difference between guideline
and reality were so great as to imply bad faith
2. Goes beyond dominance, payment, have direct interest….no,
independence requires NO TANGIBLE OR INTANGIBLE benefit that you
or a family member will get as a result of the transaction
3. Independence is really hard to prove because you get paid to be on the
board
iv. Remember- you have to own shares at the time that the incident happen
v. Demand is the rule and not the exception
vi. If the corporation rejects your demand, after using the BJR, then you can’t
continue
vii. If you don’t make a demand and prove futility, you can go ahead
1. Based on whether the majority of the board is interested
2. The majority of the board is dominated by someone interested in the
transaction
3. The underlying transaction was not as a result of the BJR
4. Then Special Committees can come in to terminate the litigation
a. Must be independent
i. Committee must establish their own independence
b. And must use BJR
c. Second approach- the above two and also the Court will review the
decision to determine if it believes whether the decision should be
dismissed
13. SEC
a. Rule 10b and 10b-5: they are two different rules
b. You have to be truthful- and also not manipulative or deceptive
c. It’s not just what you say, it’s what you fail to see as long as it’s material
14. Disclosure and Fairness
a. Primary market- creator sells to investors
b. Secondary market- investors trade securities among themselves
 c. SEC
i. Insider trading, securities fraud, short swing profits by corporate insiders,
regulation of shareholder voting via proxy, and regulation of tender offers
ii. Requires periodic disclosures by publicly held corporatios
15. Definition of a Security
a. Two broad categories
i. Specific instruments including stock, notes, and bonds
ii. A list of general, catch-all phrases such as “evidence of indebtedness,”
“investment contracts,” and “any instrument commonly known as a security”
16. Rule 10b-5
a. It shall be unlawful for any person, directly or indirectly, by the use of any means or
instrumentality of interstate commerce or of the mails, or of any facility of any national
securities exchange….to use or employ in connection with the purchase or sale of any
security registered on a national securities exchange or any security not so
registered….any manipulative or deceptive device or contrivance in contravention of
such rules and regulations as the Commission may prescribe as necessary or appropriate
in the public interest or for the protection of investors
b. It shall be unlawful for any person, directly or indirectly, by the use of any means or
instrumentality of interstate commerce, or of the mails or of any facility of any national
securities exchange
i. To employ any device, scheme, or artifice to defraud
ii. To make any untrue statement of a material fact or to omit to state a material fact
necessary in order to make the statements made, in the light of the circumstances
under which they were made, not misleading, or
iii. To engage in any act practice, or course of business which operates or would
operate as a fraud or deceit upon any person,
c. In connection with the purchase or sale of any entity
d. Halliburton Co. v. Erica P. John Fund
i. Investors can recover damages in a private securities fraud action only if they
prove that they relied on the D’s misrepresentation in deciding to buy or sell a
company’s stock
ii. D can rebut this reliance by invoking a presumption that the price of
stock traded in an efficient market reflects all public, material information-
including material misstatements
iii. The average investor believes that the information out there affecting
the market is truthful and complete
iv. Material omission or misrepresentation has to be public information to be
actionable and must also be material
 v. Assumption- the market is efficient
vi. P must have bought or sold their stock between the time the misrep went public
and the time the truth came out
1. What happens when corrected material gets published?
2. They can still sue in between the time that it went public and the time that
the corrective issue was released
3. Defenses: info wasn’t material, there was another reason for change in
share price, the Board relied on expert information that was reasonable to
rely on
4. NEGLIGENCE IS NOT SUFFICIENT
vii. To recover for 10b-5, a P must prove
1. A material misrepresentation or omission by the D
2. Scienter
a. You have to prove some intent to defraud; mere mistake is not
enough
3. A connection between the misrepresentation or omission and
the purchase or sale of a security
a. Fraud on the market theory
4. Reliance upon the misrepresentation or omission
a. If you can’t show that you traded BECAUSE OF THE MATERIAL
MISSTATEMENT, then you don’t get to bring suit
b. Presumed in the cause of action
c. Presumption of reliance can be overcome if there’s any other
element of life that you relied on (astrological signs, best friend’s
advice, on a whim)
d. For an average investor, you can’t prove reliance directly, so instead
you can prove fraud on the market theory
5. Economic loss
6. And loss causation
a. if we can prove that the price of our stock changed not because of
our misstatement but because of another factor, then you don’t
have causation
viii. Ps can in certain circumstances satisfy the reliance element of a Rule 10b-5 action
by invoking a rebuttable presumption of fraud on the market rather than proving
direct reliance
ix. IN ORDER TO PROVE FRAUD ON THE MARKET THEORY IN PLACE OF
RELIANCE:
 x. Must show that
1. The alleged misrepresentations were publicly known
2. They were material
3. The P traded stock between the time the misrepresentations
were made and the truth was revealed
xi. Defenses- other affect on market, info not material, scienter, board relied on an
expert
e. Standing
i. You must be a buyer or seller during the relevant time period BECAUSE OF THE
INSIDE INFORMAITON/MATERIAL MISSTATEMENT
f. Note: materiality- must be something of importance- what would the investor want to
know under the same or similar circumstances
i. 10b and 10b-5 do not prohibit risky investemnts, instead, it prohibits false
information
ii. 10b-5 is designed to aid the investor, not totally protect him
g. Deutschman v. Beneficial Corp.
i. Who has standing to bring a case based on this?
ii. It would be too hard to prove causation that “if you had known the truth you
would have bought/sold”
1. Anybody could say “I was going to, but…”
2. To get your foot in the door for a 10b-5 claim, you must have bought or
sold the stock after the material misstatement or omission was made and
BEFORE any corrective action was taken
iii. People who already held stock before misrepresentations lack standing
h. Note: the person who made and ADOPTED the misstatement can be liable- the attorney,
the board…etc.
i. DIFFERENCE BETWEEN 10B AND 10B-5: pg. 427
i. 10b is our general antifraud/full disclosure provision
ii. 10b-5 is more specific
17. Inside Information
a. Trading should be based on an equal opportunity to trade
b. No one should trade on information that is not public
c. It is manipulative or deceptive to trade on information that is not public
d. The CONCLUSION may not be public, but the base information may be public
 i. i.e. earthquake fault lines that a geo studies and finds that it will destroy apply
and drop its stock- that’s ok to make decisions on
e. Who is a true insider? Someone who, because of their fiduciary relationship to the
corporation, has access to non-public material information as a result of that fiduciary
relationship
f. SEC v. TX Gulf
i. Anyone who, trading for his own account in the securities of a corporation has
access directly or indirectly to information intended to be available only for a
corporate purpose and not for the personal benefit of anyone may not take
advantage of such info knowing it is unavailable to those with whom he is dealing
ii. Core of 10b-5 is the implementation of the Congressional purpose that all
investors should have equal access to the rewards of participation in securities
transactions
iii. IF YOU MAKE THE INFORMATION PUBLIC, IT HAS TO BE TRUTHFUL AND
YOU HAVE TO NOT MAKE MATERIAL OMISSIONS
iv. HOWEVER, YOU DO NOT HAVE TO MAKE INFORMATION PUBLIC
v. DISCLOSE INFORMATION TRUTHFULLY OR ABSTAIN FROM TRADING
vi. Inside information must be non-public and material
vii. Material = a reasonable man would attach importance to the information while
making his decision to trade or not
viii. Information is NOT public until there has been MEANINGFUL publication that
has had time to affect the market
ix. Telling one or two non-insiders is NOT meaningful dissemination
g. Dirks v. SEC
i. Chiarella tipper law- SEC can sue; Corporation can sue; Criminally charged
ii. Dirks got material nonpublic information from “insiders” of a corporation with
which he had no connection- so he is a tipee
iii. Tippers do not have to trade; tippees can continue to pass on information and be
both a tipper and tippee
iv. The question is whether or not they traded; tippers are liable if they traded or
not; tippees are only liable if they traded
v. Where “tippees” regardless of their motivation or occupation come into
possession of material corporate info that they know is confidential they must
either publicly disclose that info or refrain from trading
vi. Will only be liable where the insider fails to disclose material nonpublic info
before trading on it and makes secret profits
 vii. The tippee who receive nonpublic material info become subject to the same duty
as the insiders themselves- so the “tip” must also be a breach of the corporations
fiduciary duty
viii. Will the insider personally benefit from his disclosure? Absent a gain, no breach-
the absence of a loss can be a gain
ix. The employees did not violate their duty to shareholders, so Dirks also cannot
violate his duty (no fiduciary relationship when keeping fraud quiet- IT’S THE
NATURE OF THE INFORMATION THAT YOU DID/DID NOT KEEP QUIET)
h. US v. O’Hagan
i. Yes, insider trading for personal gain violates 10b-5
ii. Note: he was an outsider. He heard about it through the law firm and then used
that to make money. He was a true tippee
iii. Misappropriation Doctrine of Insider Trading: if you have a fiduciary relationship
such that you obtained non-public information from your fiduciary relationship
with the source of the information and you obtain and use that info in violation of
your fiduciary relationship and that information is non public and you traded,
you’re liable for insider trading
1. Basically, it’s a non traditional insider
iv. Tippees inherit the fiduciary relationship from the tipper
v. Insider Trading: insider with fiduciary relationship; information must be
nonpublic; must be used to make a trade
1. Remedy for this is total disgorgement (every penny used in this trade)
2. If the outsider trades or tips, they are also liable for insider trading
3. The insider can pass it on at all and will be liable
vi. The misappropriation theory holds that a person commits fraud in connection
with a securities transaction and thereby violates 10b and 10b-5 when he
misappropriates confidential information for securities trading purposes in
breach of a duty owed to the source of the information
vii. Information disclosed does not breach duty unless it is used in connection with
selling stock or security
18. Overall:
a. Was information material?
b. Was it non public?
c. Was it traded on?
d. Was the person an insider?
i. Tipper is insider who passes non public information to an outsider with the
reasonable belief that they will trade on it. Liable even if not traded. Look at
relationship tipper has with business/non public information.
19. Disclosure information
a. Is there a reason to rely on that expert?
b. The expert is responsible for misstatements that they make if it’s shown that they did
not do a reasonable investigation AND the things that they say are reasonable and they
must have appropriate credentials
c. Non experts are liable for any misstatements of experts if it was unreasonable to believe
them
d. Damages- the difference between the original price and the present price
i. Ex. Must be a link between misinformation and damage SO if bought high
number of mac stock and the day that it hits the market, Jobs gets indicted for
child trafficking and the stock plummets….well, that’s not the same
e. Elements of Blue Chip Stamp
i. Material misstatement
ii. Must have scienter- must be willful or malicious- accidental disclosure doesn’t
count- must have intent to go wrong
iii. Must prove causation between misrepresentation and purchase sale of stock
iv. Reliance on statement or omission
v. Economic loss
vi. Must be causation between loss and misstatement
f. Basic Fraud on the Market Theory
i. If you bought or sold after this misrepresentation or omission came out to the
public, the market was affected and not the individual investor
ii. An investor who acts after that relies on the market and not the
statement/omission
20. The LLC
a. Good features of partnerships and good features of corporations and none of the
negatives
b. No personal liability
c. Right to Manage
i. When they sell their interest, this does not attach.
d. Liability shield for members
e. LLC only gets taxed once
f. Shareholders have no fiduciary duty
g. Capital contribution- you have to give capital because you aren’t personally liable
h. NO SEC- but traded
i. For practical purposes, you do not want to have a large number of people as owners
j. Operating agreement- just the rules for how we’re going to operate our business
k. LLCs are flexible- you can agree on almost anything
i. Can’t vary liability to third parties
l. Generally the SEC rules do not apply
m. Duray Development, LLC v. Perrin
i. Most state statutes find that de facto and by estoppel corporations are of no value
ii. He wants de facto corp, but that doesn’t apply to LLP
iii. LLC comes into existence begins on the effective date of the articles of
organization as provided when they are endorsed by the minister
iv. De facto corporation: when incorporators have
1. Proceeded in good faith
2. Under a valid statute
3. For an authorized purpose
4. Have executed and acknowledged articles of association pursuant to that
purpose
5. You THOUGHT you did everything you needed to do (in good faith) so you
get the protections of the corporation
v. Then a corporation de facto comes into being. It’s an actual corporation
vi. Corporation by estoppel is nothing more than an equitable remedy to stop
someone from arguing that there was not a corporation
1. If the person dealt with it as a corporation, it can’t argue “oh, there’s no
corporation”
vii. Both apply to LLCs
n. Fisk Ventures LLC v. Segal
i. The LLC law endows both Class A and class B members with rights and
protections
ii. You have to do what’s best for the company and not the members- but you def
can decide “I don’t want to do this anymore”
iii. The mere exercise of one’s contractual rights, without more, cannot constitute a
breach of the implied covenant of good faith and fair dealing
iv. Negotiating forcefully and within the bounds of rights granted by the LLC does
not translate to a breach of the implied covenant