Corporations Outline: Introduction to Corporate Law: Participants in the Corporate Structure:.................................................1 Foundations for Corporate Law:.............................................................
2 Management of Corporations.................................................................5 Fiduciary Duties......................................................................................6 Corporate Finance (could spend some additional time here)...............16 Disregarding the Corporate Entity (Piercing the Corporate Veil)..........19 Civil Liability – Rule 10(b)-5 Claims......................................................23 Insider Trading.....................................................................................29 Shareholder Voting:..............................................................................34 Corporate Acquisitions, Takeovers, and Control Transactions.............45 The Williams Act:..................................................................................56 Mergers:...............................................................................................57 Partnerships, Limited Partnerships, LLCs.............................................60
Participants in the Corporate Structure:
• Managers: o Appointed by the Board of Directors to run the company (can also be removed by the board) o Encompasses the CEO, CFO, COO, etc o CEO tenure has decreased in recent years as a product of investor activism, global competition… This is one reason for the increased pay-rate demanded by CEOs Directors: o Independent Director Director that has no direct or indirect relationship with the company o Outside Director Directors that have no employment or consulting role with the company outside of the director relationship An outside director may, however, have an interest in the wellbeing of the company through another relationship o Audit Committee: Boards of Directors typically act through committees – one being the audit committee Maintains oversight over the company’s accounting and financial reporting processes o Board of Directors:
Members of the board, individually, can do nothing – the only power that exists is vested in the board as a whole. The board only has the power to act when it is in a meeting: • The meeting must be duly called (according to the rules outlined in the bylaws, charter, etc.) • Action by Consent – If there is a resolution that is signed by all the directors, it can have the authority of the board. o Not used in all situations because there is no deliberation and consensus after a thorough discussion (can pose a problem in a lawsuit) o Post-Enron: Revised listing standards from NYSE and Nasdaq Majority independent boards are required Listed companies must have a nominating committee (for hiring) and a compensation committee comprised entirely of independent directors Tighter definition of an independent director (pg 12) Shareholders: o Two basic features characterize ownership in public companies: Ownership is dispersed among participants in the market A significant percentage of the ownership lies with institutional investors (pension funds and mutual funds) o Shareholder activism Different shareholders have different goals • Pension funds are typically “buy and hold” investors and therefore have more incentive to engage in proxy battles and litigation • Mutual funds are active traders and will simply sell their investment in a stock and move the money elsewhere
Foundations for Corporate Law:
• The fundamental place to start is State corporation law: o Model Business Corporation Act Most states follow this act (some more closely than 2
others) o Delaware: Not a model state, but the majority of corporations and the value of those corporations dwarfs the rest of the country combined Why is DE so popular? • Race to the Bottom Theory: o Delaware’s statute is designed to give management leverage and flexibility in designing corporate charters o “Pro-management” o Even though DE has a franchise fee, corporations are willing to locate there because of the benefits • Race to the Top Theory: o If a state made a rule that was too lax, investors would not want to put their money in a corporation located there o Investors like investing in Delaware corporations – therefore the rules must be advantageous • Other reasons: o Delaware is very efficient in dealing with all things corporate (filings, paperwork, etc.) o The court system has evolved to benefit corporations and shareholders alike (access to the courtroom, jurisprudence, a court that is devoted to corporate law) Federal Laws: • Basically deal with disclosure • Securities Exchange Act of 1933 (302): o Regulates transactions in securities o Basic strategy: Create a mandatory system of disclosure – limited to the initial distribution of securities If investors were provided with all the material information about a security there would be no unfair informational advantages o SEE BELOW FOR MORE DETAIL • Securities Exchange Act of 1934 (303): o Created a continuous disclosure system
attestation. you pay for the privilege and the exchange actively markets itself • Stock Exchanges are strictly regulated by the SEC – therefore they have to enforce their own rules
. or The corporation files a ’33 Act registration statement that becomes effective o SEE BELOW FOR MORE DETAIL • Sarbanes-Oxley Act of 2002 o Serves as an amendment to the Exchange Acts o A public company cannot loan money to its executives or directors o Created the Public Company Accounting Oversight Board Oversees the audit of public companies that are subject to the securities laws The board has rulemaking authority with respect to auditing. or Any class of its equity securities is held of record by at least 500 personsand the corporation has gross assets over a specified level. quality control and ethics Section 201 – prohibits accounting firms from providing a variety of non-audit services to an audit client (controversial) Requires securities exchanges to adopt listing standards under which a corporation’s audit committee must be composed entirely of independent board members Stock Exchange Rules • Self-regulatory organizations – hybrid public private enterprises • If you are listed on an exchange.
o A corporation is subject to the ’34 Act if: It lists its securities on a national securities exchange.
o Prevents the inevitable conflict of interest when an organization has to regulate its own customers Charters: • Certificate of Incorporation / Articles of Incorporation • Amendment requires both board and shareholders Bylaws: • Laws that the Board or Managers have enacted and must abide by • Either the shareholders or the directors can amend the bylaws • Bylaws cannot contradict the law above – cannot contract out of the law by passing a bylaw
Management of Corporations
• • • • Management of the regular business affairs is vested in the Board of Directors. but solely from the agency relation and exists for the protection of persons harmed by or dealing with a servant or agent Authority is based on an individual’s office or station within a company 5
. who have been elected by the shareholders Officers of the corporation are normally appointed by the Board Fundamental corporate changes require approval by the shareholders. usually on recommendation by the Board Officers of the Corporation: o Authority: Menard (59): • Actual Authority – Has the board given the agent (officer) the authority to engage in a particular act? • Apparent Authority – Has the board implied (to the third party) that the agent has the authority to act? o The board’s direct or indirect manifestations to the third party and not from representations of the agent himself • Inherent Authority – The power of an agent that is not derived from authority or apparent authority.
signed a guarantee for a friend o Court found no actual or apparent authority o Cannot be inherent authority – this line of dealing has nothing to do with the business o Bank should have acted more reasonably and looked for confirmation from the board or the CEO Ultra Vires Doctrine: • Originally – A corporation could only act to accomplish the specific goals it was established to accomplish o i.
General Rule – The court is going to find in favor of the party that acted the most reasonably Treasurer’s Authority • Goth v. Coca Cola could not go into the real estate business because it was specifically formed to sell beverages • To prevent overarching monopolies.e. Anaconda (63): o Kraft. treasurer. corporate charters included language stating the specific line of business that the corporation intended to engage in – and the corporation was limited to this line of business • Delaware eventually moved to broaden a corporation’s abilities • Ultra vires can still be raised in some contexts: o Corporate guarantees of third party debts that do not benefit the corporation o Non-profits – excessive charitable contributions may be viewed as wasteful and ultra vires
• Fiduciary Duty: o Generally defined as one who is given power that carries a duty to use that power to benefit another o The primary problems faced by shareholders are mismanagement of the business or unfair self-dealing by those in control of the corporation o Sliding Scale:
Duty o o
There is a tension between the different analyses that a court will use in a breach of fiduciary duty case (ranging from the Business Judgment Rule to a Fairness Analysis) Plaintiffs and Defendants want different levels of scrutiny from the court (the ones that benefit each party the most) The court “slides” along the scale of options to provide the most amicable result based on the facts presented in the case of Care: Requires directors to perform their duties with the diligence of a reasonable person in a similar circumstance Duty of Care issues typically come up in two contexts: There is a decision made in a negligent manner There is a failure to act or monitor where a loss could have been prevented Business Judgment Rule: The Golden Rule of corporate law The Business Judgment Rule is a rebuttable presumption that directors in performing their functions are honest and well-meaning. you must overcome the business judgment burden in court Must show: • The action by the board was not in good faith o Fraud. the act was illegal. directors may not have the incentive to join boards in the first place Overcoming the Business Judgment Rule: As a plaintiff. and that their decisions are informed and rationally undertaken Justifications: • Encourages corporate risk-taking – without the business judgment rule directors may not take the risks necessary to maximize profits • Avoids judicial meddling – judges don’t want to make business decisions • Encourages directors to serve – w/o the Rule. director had a conflict of interest • The action lacked a rational business purpose • Gross negligence on the part of the board • Inattention – directors are not exercising their oversight duties 7
. conscious disregard.
Van Gorkom (Trans Union) • When are directors not informed? • The court used the Gross Negligence standard here • The directors claimed they weren’t grossly negligent: o They got a substantial premium on the company’s stocks over the current market value o The merger contract allowed for a market test o The board was knowledgeable about the business o The board had relied on counsel’s advice that failure to accept the bid would result in litigation • The court did not agree:
. but the majority shareholder doesn’t believe baseball should be played at night • Court dismisses the plaintiffs argument because Wrigley claimed the reason for not playing baseball at night was the potential degradation to the surrounding neighborhood and loss of real estate value o Even though this reasoning is relatively ludicrous. AT&T • AT&T did not collect on a phone bill to the DNC • While the board may have been able to come up with a reason for this. there is a law in place (campaign finance) that forbids such actions • Because there was a financial DAMAGE to AT&T because of the board’s actions. the shareholders were allowed to bring suit – otherwise fiduciary cases cannot be used as a vehicle to get you into court Smith v. the court didn’t want to take it any further – the board had a reason. it wasn’t entirely irrational. so it passes muster Miller v.o Director cannot sit by if he knows that the CFO is embezzling money o Cases: Wrigley: • Shareholders want Cubs to play night-ball.
but they did not rise to the level of recklessness • After 102(b)(7). the board must hit recklessness Stone v.•
o Even though they got a substantial premium. even if you get a good result. Ritter: • Director Oversight is subject to review under the duty of good faith – which is a subset of the duty of loyalty o This was unclear before this case
. but the process Therefore. the process leading up to it needs to be good o Any time a board is making an important decision. they have to sit down and genuinely deliberate All that matters if a decision goes to court is whether the board deliberated properly DGCL 102(b)(7) o Enacted after Van Gorkom o Eliminates monetary damages for breach of duty of care cases Still liable for acts not in good faith or breaches of the duty of loyalty o Essentially takes the teeth out of the duty of care
In re Walt Disney: • Post-DGCL 102(b)(7) • The actions taken by the board weren’t great. negligence is not enough to recover. only accept them o The directors had only discussed the events of the offer briefly and never got a financial consulting firm to validate the deal Lessons: o The court does not want to look at the result of a decision. it was useless without valuation information from elsewhere to validate the offer price o Market test was not useful – Trans Union was not allowed to ask for other bids.
but that the courts would review such a contract if it was found to be unfair to the corporation Burden of Proof: Once a challenger shows the existence of a conflict of interest. it is up to the challenged director to prove the conflicted transaction’s validity (see below – depends on state) Under a duty of loyalty analysis – the defendants are not afforded the protections of the business judgment presumption (bolster this)
. shareholder. but fails to implement anything to mitigate the problem of Loyalty (110): Requires the fiduciary to act for the best interests of their corporation and in good faith Can involve intentional dereliction of duty.•
Duty of faith issues arise when there: o Is an intentional act in not advancing the corporation’s best interest o Is an intent to violate positive law o Intentionally failing to act in the face of a duty to act • There are two categories: o If the board fails to consider an option that could be a threat or problem – this could be a breach (ie forgets to follow the law o If the board considers the option. or a conflict of interest where an individual’s interests will be elevated above that of the corporation Common law rule: A corporate contract with one or more of its directors – or with another corporation or business enterprise in which one or more of the directors was associated as a manager. or actual intent to cause harm to the corporation. or partner – was voidable irrespective of fairness Became more liberalized over time Modern Rule: The general rule is that no transaction of a corporation with any or all of its directors was automatically voidable at the suit of a shareholder. whether there was a disinterested majority of the board or not.
the contract or transaction is fair and reasonable to the corporation. negotiation and approval o Statutes dealing with interested directors: Weak Form Approach: • Follows the common law approach to an extent • Contracts must be fair – the burden of proof always falls to the fiduciary • Cookies Food – Burden of proof belonged to Herrig through the entire case to prove that he had not breached the duty of loyalty o The majority felt he carried that burden o The dissent felt that he did not meet the burden even though the court had interpreted the law correctly o This is arguably the hardest test to pass – see below – and yet the court has determined that Herrig passed it • Iowa Statute: o The contract or agreement shall not be voidable if: the interest is disclosed and the interested director does not vote. Semi-Strong Approach: • Statutory compliance with disinterested director approval shifts the burden of proof
. the interest is disclosed and the shareholders authorize the agreement.o Judicial Fairness Tests: Substantive Fairness: • Did the director’s interest win out over the corporation’s interest? o Objective test – is the price paid reasonable? o Value to corporation – was the transaction valuable to the corporation? Procedural Fairness: • Whether the directors who approved the transaction lacked independence and acceded to their interested colleague? Elements to consider include: o Was everything disclosed to the board? o What was the composition of the board? o What role did the interested director play in the transaction’s initiation.
Wholly owned subsidiaries: • Few problems here – virtually unfettered discretion to do whatever you want with the subsidiary Partially owned subsidiaries: • This is where the problems can occur – if the parent (as the majority stockholder) forces the subsidiary to do something against its interest. Levien (131): • The court applied the business judgment rule to the allocation of dividends because all
. the burden then shifts to the defendant to prove that its transactions with the subsidiary are objectively fair o If the plaintiff cannot show that the transaction is clearly preferential to the parent. Disinterested board approval shifts the burden to the plaintiff and removes the fairness inquiry
o Special Case – Parent Subsidiary Dealings Dealings between a controlling shareholder (the parent) and the corporation (the subsidiary) raise many of the same conflict-of-interest concerns as do dealings between a director and the corporation.
from the defendant to the plaintiff but retains a fairness test • New York Statute – 119 • California Statute – 120 Strong Form Approach: • Approval by the disinterested board would generally limit judicial inquiry. the court will apply the Business Judgment Rule Sinclair Oil v. there may be grounds for a suit o Unfavorable contract terms o Dividend policy Judicial Review: • Dichotomy: o If the plaintiff can show clear parental preference for a transaction (burden starts with the plaintiff to show preference) – the court should apply the Intrinsic Fairness Test: Under this test.
independent. disinterested directors. it should avoid a fairness review in court • Courts often defer to the decisions of directors when dealing with compensation – especially independent directors • Lack of good faith (which violates the duty of loyalty) could provide a platform for plaintiffs if it can be proven o Backdating stock options is one example • Waste Doctrine: o If compensation is approved by a board of independent. Hill – tobacco case (140) o Walt Disney – “plaintiffs must shoulder the burden to prove that the exchange was so one-sided that no business person of ordinary sound judgment could conclude that the corporation has received adequate consideration 13
. It does not matter that the minority shareholders were claiming that this aided the parent – the minority did not effectively prove that the transaction was clearly preferential to the parent
o Special Case – Compensation of Managers Forms of Compensation: • Salaries and bonuses – direct compensation • Stock plans – incentive compensation • Pension plans – deferred compensation Judicial Review of Compensation: • Executive compensation plans have to be authorized by the board – if this approval comes after work by a disinterested. the plaintiffs may attempt to show that there is no relation between the compensation level and the executive’s services only then will the court consider interfering with the director’s approved compensation level o Rogers v.•
shareholders got their fair apportionment. independent compensation committee and it is approved by informed. disinterested directors.
Corporate Opportunities Doctrine • Subset of the Duty of Loyalty – balances the corporation’s expansion potential and the manager’s entrepreneurial interests • Corporate managers have a duty to loyally put corporate interests ahead of their own o This includes taking a profitable business opportunity away from the corporation • Irving Trust Co. o Individuals later sold their stocks for a significant profit. Company didn’t have the funds necessary to purchase the stock – a group of directors and employees came forward and offered to purchase the stock and provide the benefits of access to the patents to Company. Michaels (167): o Guth Rule: If there is presented to a corporate officer a business opportunity which the corporation is financially 14
. v. Deutsch (161) o Company wanted to purchase stock of affiliate to gain access to patents. although Company was not effected because it already had access to the patents o Issue: whether the prohibition against corporate officers acting on their own behalf is removed if the corporation itself is financially unable to enter into the transaction? o Holding: No. directors might not try very hard to get funding before simply opting to fund ventures themselves – and capitalize. Company agreed. Directors of a solvent corporation are forbidden from taking for their own profit a corporate contract on the plea of the corporation’s financial inability to perform. This rule does not apply to employees who don’t have fiduciary duties • Rapistan Corp. v. Policy: without this rule.
. is not essential to his corporation. •
able to undertake. the officer is entitled to treat the opportunity as his own. Tests for whether Corporate Opportunities exist: Interest / Expectancy Test
o Corp has an interest in an opportunity if it has some contract right regarding the opportunity o Corp has an expectancy concerning an opportunity if existing business arrangements lead it to reasonably anticipate being able to take advantage of the opportunity. in the line of the corporation’s business and is of practical advantage to it. the law will not permit him to seize the opportunity o Guth Corollary: When a business opportunity comes to a corporate officer in his individual capacity rather than in his official capacity. from its nature. one party had already been investing in real estate when the corporation was formed and that party was also not a full-time or a fullyinvested member of the corporation. Horn (170): o Court does not apply the line of business test – here. because of the nature of the enterprise. and is one in which it has no interest or expectancy. is one in which the corporation has an interest or a reasonable expectancy. and the opportunity is one which. which is. the self-interest of the officer or director will be brought into conflict with that corporation. and by embracing the opportunity. the corporation did not have the expectancy that these opportunities would belong to the corporation. Therefore. and the corporation has no interest in it • Burg v.
it is in the money and will be exercised Common stock in a corporation that has also issued debt has the characteristics of a call option – if the debt comes due and the corporation cannot repay it. Present value is used to determine the feasibility of a project If the net present value is a positive number.•
Line of Business Test
o Corporate opportunity exists if: closely related to the corp’s existing or prospective activities • Fairness Test
o Court measures the overall unfairness which would result if Dir. It will also indicate which of two or more projects of equal size is the most profitable. Took Opp for himself. the project will likely be a good one for the firm to undertake Net Present Value Takes account of the cost of money and produces an answer to the question whether a project is worthwhile or not.
Corporate Finance (could spend some additional time here)
Time Value of Money: Present Value = Future Value / 1+r This is present value for a future value of one year in the future If you want to do multiple years in the future you take it to the power of that number (see example on 181. the corporation goes into re-org and there is a chance that the stockholders get eliminated 16
. If the value of the asset is greater than the exercise price at maturity. which is the average of all possible returns weighted by
Stock Options: o Calls:
Gives the holder the right to purchase from the writer of the option a specific asset at a specified price (strike price) at a specified time. Expected Value The return for an uncertain investment is called the expected value.
are more accepting of volatility (based on the potential upside) The time to expiration Stock: o Common Stock Can actually be a form of option • If debt is issued it will come due at a certain point • At this time. the company will either be worth more than the outstanding debt or less o If the company is worth more than the debt issued.•
o Puts: A put option giver the holder the right to sell to the writer of the option a specified asset at the exercise price. on the other hand. the stockholders will not exercise the option to repay the debt and will instead hand the company over to the bold holders Preferred Stock: o Midway on the continuum between common stock and debt o Like stock in that its claim to income and assets is subordinate to that of debt o Like debt in that its claim to income and assets is superior to stock Dividends:
. the stockholders will pay back the debt and take the remaining upside and keep the business o If the company is worth less than the outstanding debt. • If the value of the underlying asset is less than the exercise price it is in the money and will be exercised o The Determinants of Option Value (Black Scholes(sp) formula) (equations on 212-216): The current value of the underlying asset The exercise price The time value of money (see above) The variability of the underlying asset (this is probably the most important element) • Bond holders are much less accepting of volatility • Stockholders.
it is immediately reflected in the stock price.•
o Payments to shareholders that represent a current return on investment – paid at the discretion of the directors o Legal requirements for payment of dividends differs among states o Basic Principle – don’t permit payment of dividends in cases where the payment will adversely affect investors or creditors If dividend payments deplete a company’s capital creditors and stockholders could be harmed in the future Efficient Capital Market Hypothesis: o The share price set by the market can be a benchmark for the performance of the business and its management In order for this to work. do not encompass information from sources Kamin v. American Express: o AMEX made a bad business investment and purchased a company whose stock later plummeted o AMEX decided to issue a special dividend to shareholders and give the company away to them o Stockholders filed suit saying that AMEX should have sold the stock at a loss and then written the loss off on their books o AMEX says it does not want the bad press from selling the stock (will impact stock prices poorly) o Court says that is fine o This is a duty of care question – similar to Wrigley
. o Three levels of market efficiency: Weak form efficient – prices reflect all information about past stock prices (the idea that the price is only indicative of historical information) Semi-strong form efficient – prices also reflect all publicly available information such as financial statements and earnings reports Strong form efficient – prices reflect not only public information but private information as well There are significant arguments for the idea that markets are not rational at all and therefore. the shares must be traded in an efficient market o The Efficient Capital Market Hypothesis claims that the numerous active traders in the stock market react quickly and efficiently to information whenever new information is available about a company.
injustice or unfairness o The Plaintiff must show harm Factors in Piercing: o Inadequate Capitalization – was the corporation purposely structured so that there were few or no assets o Corporate formalities observed – its easy to tell if the corporation observed formalities o Fraud or injustice – Was there a misrepresentation? Would the adherence to the fiction of a separate legal entity sanction a fraud or injustice? o Was the entity simply the alter-ego of the shareholder? o Are you piercing to reach an individual or a corporation? Easier to reach another corporation because it doesn’t defeat the idea of limited liability (as much) Easier to pierce to reach fewer shareholders rather than more Perpetual Real Estate v. who is also the sole shareholder for a company. Michaelson Properties: o Contract claim against individual o Alter Ego Test The corporate entity was the alter ego of the individuals sought to be personally charged • Easily proven in this case The corporation was a device or sham used to
. the corporation has been legally formed – there are no issues with incorporation A frequent example occurs where a party wants to hold an individual. the individuals behind a corporation are protected by limited liability for the actions of the corporation In these cases.
The court does not want to look into the reasons behind a decision. liable for actions of that company o Often the individual is another corporation – a wholly owned subsidiary How to Pierce (Plaintiff bears the burden to prove these): o Shareholder must control and dominate the corporation o There must be fraud. as long as there are reasons
Disregarding the Corporate Entity (Piercing the Corporate Veil)
• Party attempts to hold the shareholders. directors and officers of a company personally liable for some action o Normally.
Polan o Contract claim against individual o Suit to recover on sublease o Test: Is the unity of interest and ownership such that the separate personalities of the corp and the individual shareholder no longer exist? Would an equitable result occur if the acts were treated as those of the corp alone? Court assumes that the creditor has conducted an investigation prior to entering into a contract – otherwise it is on the creditor and piercing is not allowed o Piercing is allowed because of the failure to observe corporate formalities Its important to observe formalities!! Sub-Topic – Parent Subsidiary Relationships o Is it possible for a claimant to make a claim against a subsidiary’s parent if the sub doesn’t have the assets to fulfill a claim? o Fletcher v. or conceal crime • Hard to prove here o Piercing not allowed Kinney Shoe Corp. v. Atex Tort claim trying to reach the parent corporation Test: Plaintiff must show • The parent and the subsidiary operated as a single economic entity • That an overall element of injustice or unfairness is present Factors for whether parent and sub act as a single economic entity: • Whether the corporation was adequately capitalized for the corporate undertaking • Whether the corporation was solvent • Whether the dividends were paid. and other formalities were observed • Whether dominant shareholder siphoned corporate funds
Corporate Disclosure and Securities Fraud • Why do we need securities fraud laws? o Without them there would be very little trust in the 20
disguise wrongs. records kept. obscure fraud. officers and directors functioned properly.
the volume of trading that takes place would be significantly diminished o Required disclosure allows the market to accurately assess information Securities markets are different than other markets in that you cannot touch the product. o INITIAL OFFERING REQUIREMENTS o Expansion on common law fraud: Holds the issuing corporation strictly liable for material misrepresentation or omission in its offering documents Makes those who participated in the offering liable for the issuer’s failure to disclose unless they could satisfy the burden of proving that any such material error or omission could not have been reasonably detected by them o Elements: Registration Filed with the SEC Prospectus • Describes Business • Risk Factors • Financial Information o What is not subject to the ’33 Act? Registration process is not applicable if the offering is only available to funds or other corporations Registration process does not apply if the operation and the transaction are small • Starting a business in your garage and selling stock to neighbors
marketplace and theoretically. but they don’t cover the range of needs presented by securities o Most individuals agree that some level of securities regulation is necessary the debate occurs when discussing how much regulation is necessary Securities Act of 1933: o Basic strategy of the act was to create a system of mandatory disclosure to supplement the preexisting law of fraud If investors were provided with all material information about the security to be offered there would be no unfair informational advantages and the security would not be overpriced. you don’t want the current product (the stock). you want the promise of future returns o There are general anti-fraud laws.
Ordinary market transactions – day-to-day stock trading Securities Exchange Act of 1934: o Continuous disclosure system Regulates the secondary market (trading among investors) o A corporation is subject to the ’34 Act if: It lists its securities on a national securities exchange; The corporation has gross profits over a certain level (currently 10,000,000); or The corporation files a ’33 Act registration statement that becomes effective o Reporting Requirements: Annual Reporting (Form 10-k) • Audited financial statements • Percentage breakdowns of the lines of business Quarterly Reports (Form 10-Q) • Unaudited financials for each of the first three quarters of the fiscal year Form 8-K • Released when major contracts are signed • Significant management changes take place Proxy Statement • Sent out before annual meetings • Explains the matters that will be up for vote during the meeting o Rule 10b-5 SEE BELOW Blue Sky Laws: o State regulatory laws Exchange Rules: o Govern the members that list with an exchange (NYSE / Nasdaq) o Have rules that govern when a significant event must be disclosed to the public o Both major exchanges have relatively similar rules When does a disclosure obligation arise? o Timing: Financial Industrial Fund v. McDonnell Douglas • A corporation is entitled to withhold disclosure until information ripens
Plaintiff has the burden to prove that it exercised due care in purchasing stock, that the defendant failed to issue appropriate information when sufficient information was available for an accurate release, and there existed a duty between the plaintiff and the defendant to release the information o Merger Discussions Basic v. Levinson • Whether merger discussions in any particular care are material depends on the facts. • Board resolutions, instructions to investment bankers, actual negotiations between principals or their intermediaries may serve as indicia of interest • Materiality depends on the significance the reasonable investor would place on the withheld or misrepresented information o Duty to Update: Backman v. Polaroid Corp. • Is there a duty to update projections after the initial information is provided? o There can be, but the information must be material to the reasonable investor (and probably information that cannot readily be inferred through the other information already released) There is no duty to update periodic SEC filings – they “speak” only as of the day of publication
Civil Liability – Rule 10(b)-5 Claims
• A plaintiff potentially has a wide array of remedies available to him if a corporation issues a material misstatement or omission in connection with the purchase or sale of a particular security o Bring action at common law or equity o Assert a private cause of action under state “blue sky” laws o Assert a private cause of action under federal law – 10(b)-5 Rule 10(b)-5 o Implied Civil Liabilities (basically judge-made rule) o Applies to both a purchaser and a seller in securities 23
transactions o Based on Sec. 10 of the 1934 Securities Exchange Act The Rule does not explicitly provide for a private cause of action, however, courts easily implied one, first in 1946 and then explicitly in 1964 Without the implication that the rule applies to private actions, it would be left solely for the SEC to utilize o Elements of a Cause of Action under 10b-5 Elements: • Standing • Materiality • Causation • Scienter • Damages Standing: (if time, read more from this section – 353368) • Birnbaum Doctrine – Purchasers and Sellers o Only actual purchasers and sellers may recover damages in a private 10b-5 action o Therefore, if a false or misleading statement leads a person not to buy or sell, there is no 10b-5 liability o Blue Chip Stamps v. Manor Drug Stores: The rule does not cover offers to sell, but only actual sales or purchases • Mergers: o Traditionally mergers have been recognized as sales for purposes of Rule 10b-5, even when the shareholder does not make or vote on any investment decision – Forced Seller This theory is in dispute now Materiality: • Defendant affirmatively misrepresented a fact, or omitted a material fact that made his statement misleading, or remained silent in the face of a fiduciary duty to disclose a material fact • Materiality = % chance of issue occurring (P) x the magnitude of the event (M) o This must also be compared against the 24
then it is material enough that it should be disclosed. Virginia Bankshares v. even conclusory ones are actionable under 10b-5 Must allege facts that make this 25
. under the Act. even if a knowingly false statement is not actionable if it is accompanied by appropriate cautionary statements SEC v. Sandberg: o Holding company wants to buy out its minority shareholders o Board comes up with a price and represents it as a “good” price o Shareholders sue under 10b-5 on the premise that the board does not believe this statement to be true o Court: Statements of the board. Texas Gulf Sulfur: o Executives purchased stock based on the information they received from an exploratory search o If the materiality of the event is such that other investors would likely want to pursue the same strategy.•
size of the company – what is material for a little company may not be for a larger one Bespeaks Causation Doctrine: o The inclusion of sufficient cautionary statements in a disclosure document renders misrepresentations and omissions unactionable o It is incumbent on investors to read all information available to them and make a deliberate decision based on that information (not just the information that works in their favor) o “Total Mix” o Private Securities Litigation Reform Act of 1995: Amends the ’33 and ’34 Acts Fortifies the Bespeaks Causation Doctrine Apparently.
manipulate. Levinson: o In the case of false or misleading statements in an open and developed securities market. courts will infer that investors have relied on the misinformation • Dura Pharmaceuticals v. or defraud • Ernst & Ernst v. Brouda o The plaintiff must prove that the fraud produced the claimed losses to the plaintiff o Plaintiffs cannot simply allege losses caused by an artificially inflated price due to “fraud on the market” but must allege and prove actual economic loss proximately caused by the alleged misrepresentations Scienter: • The mental state requirement – plaintiff must show that the defendant’s mental state embraced the intent to deceive. courts have created a rebuttable presumption of reliance o If material misinformation artificially distorts the market price of a security. United States: o In a case where the defendant fails in a duty to speak. courts will dispense with proof of reliance if the undisclosed facts were material • Basic v.
believable • Here there were numerous facts disclosed to the board that were not shared with shareholders Causation (reliance): • There must be a link between the plaintiffs decision to buy or sell and the defendant’s actions (this is the reliance piece) • There must also be a link between the misrepresentation and the plaintiff’s loss (this is the causation piece) • Affiliated Ute Citizens v. Hochfelder: o Accounting firm was negligent when it failed to audit company’s books and uncover a corrupt CEO’s actions this is 26
there are three types of damages: o Rescission: Allows the defrauded plaintiff to cancel the transaction Pg 419 – court allowed for damages beyond loss where the defendant’s profits from the transaction exceeded the plaintiff’s loss (under the idea that the defendant shouldn’t profit at all from fraudulent actions o Cover Damages: Only applies when the plaintiff. CoAs have since found recklessness sufficient to trigger 10b-5) • Pleading scienter: o Tellabs v. Makor You have to plead with particularity the facts that give rise to a strong inference of fraud In order to survive a motion to dismiss. sells the stock The difference between the price at which the plaintiff transacted and the price at which the plaintiff could have transacted once the fraud was revealed o Out-of-Pocket Damages: Most common Plaintiff recovers the difference between the purchase price and the true value of the stock at the time of purchase
not enough for a 10b-5 action o There must be an intent to deceive on the part of the defendant o The court did not address whether recklessness would trigger 10b-5 (however. in an attempt to mitigate losses. your claim must have a cognizant change of success in light of all the surrounding facts Damages: • According to class.
then a 10b-5 claim may be formulated o Aiding and Abetting fraud in the sale of securities Central Bank of Denver v. First Interstate Bank of Denver • Secured bonds require that the “secured” property be worth 160% of the outstanding principal plus interest • Bank got an appraisal that said the land may have declined in value but the bank did not check into the situation and the bondholder defaulted on the loan 28
.o Defenses to a 10b-5 claim: Statute of Limitations: • Two-year statute of limitations for private 10b5 actions o After discovering facts that constitute a violation • Implemented under Sarbanes-Oxley Contribution: • Defendant can seek contribution from others at fault • Based on percentage of responsibility • Transactions not covered by Rule 10b-5 o Corporate Mismanagement Santa Fe Industries v. Bankers Life • Here a corporate mismanagement claim also included elements of fraud – if that is the case. no fraud o Causes of action based on breach of fiduciary duty without a disclosure claim belong in state court However – Superintendent of Insurance v. Green • Santa Fe short-formed a minority shareholder out of its shares • Hired a financial firm to propose a good price – firm came back with $150 • Minority shareholders were told of their appraisal rights • Minority instead tried to file a claim under 10b5 • Court: o There was no lack of disclosure in this case and therefore.
material information to purchase stocks by insiders Does it apply to outsiders? Why is insider trading inappropriate? (theories for regulating) o Fairness It is not fair for those who trade without access to material.•
Court: o The scope of §10b is broad. the parameters that plaintiffs use to get into court are slightly different (428429)
• There are multiple sources of law that deal with insider trading: o Rule 10b-5: the federal “abstain or disclose” rules o §16(b) of the exchange act: intended to chill short-term speculative trading by insiders o State laws o Sarbanes-Oxley: new rules on insider trading What is insider trading? o Utilization of non-public. however. the defendant must engage in actual fraudulent behavior and not merely provide collateral assistance
The Private Securities Litigation Reform Act of 1995 (423-429) o In relation to Rule 10b-5 o Passed partially in response to the belief that plaintiff’s attorneys were taking advantage of the current rule structure and were benefitting more from the litigation than the plaintiffs o The Act seeks to make conditions more favorable for plaintiffs than plaintiff’s attorneys. and rid the courtrooms of frivolous lawsuits o The volume of post-Act litigation has been close to the same as pre-act litigation. and can reach all who are involved directly or indirectly with deceptive practices o However. non-public information • Not generally accepted by state corporate law o Market Integrity Outsiders will be more leery of acting because they are unsure of what the insiders know 29
United States: • Individual was prosecuted for using information obtained in a copy room to trade on. • First case that suggests insider trading might violate Rule 10b-5 Chiarella v. the copy-boy had no fiduciary duty to anyone) • Rule 14e-3: o Modified post-chiarella o Discussed at length in US v. • Supreme Court reversed – Rule 10b-5’s obligation to disclose or abstain arises only when there was a fiduciary duty owed to the corporation or its shareholders (in this case. SEC • A breach occurs when an insider gains some direct or indirect personal gain or a reputational benefit that can be cashed in later o In this case.•
Only somewhat acceptable (ECMH posits that more information is better for everyone) o Cost of Capital Insider trading leads investors to discount the stock price of companies when insider trading is permitted making it harder to raise capital o Property Those who trade on confidential information reap profits without paying for the information (through research/risk-taking/other admirable traits in the market) Federal Law: o Rule 10b-5 In re Cady Roberts & Co. Secrist was not divulging the information to gain from it – but to warn of fraud taking place in his company • A tippee (someone that has received information from an insider) assumes a fiduciary duty to the shareholders of a corporation only when the insider has breached his fiduciary duty to the shareholders • Post-Dirks:
. O’Hagan o Any person in possession of material non-public information about a tender offer is prohibited from sharing or trading on such information Dirks v.
o Insiders: Traditional – directors.Forbids companies from selectively disclosing material non-public information to important members of the investment community • Reasoning – Selective discussions with securities analysts (etc) is essentially systematic tipping of valuable insider information • There is no private cause of action under FD • Bars disclosure only to market professionals and shareholders likely to trade
. lawyers o Outsiders (with a duty to the source) Outsiders with no relationship to the company have a duty to abstain or disclose when they are aware of material. controlling shareholders Temporary – accountants. non-public information obtained in a relationship of trust or confidence Is this 10b-5(2)? o What must a tippee know to be liable? Those without an inherent confidentiality duty inherit one when they knowingly receive improper tips from an individual who breached a confidentiality duty o Tippers: Insiders and outsiders with a confidentiality duty who knowingly make improper tips are liable as participants in insider trading HOWEVER. the tipper must expect some reciprocal benefits for the tip (Dirks) • (this is different from the liability under 14e-3) Regulation FD: • This is the Post-Dirks rule • Fair Disclosure • Purpose . employees.
If disclosure is intentional – it must be done simultaneously with the entire market • If disclosure is unintentional – the company must promptly disclose information to the rest of the market (within 24 hrs) • Exclusions from the Rule: o Does not apply to IPOs o Normal course of business o Disclosure to media or government officials – under normal circumstances o “road shows” or other SEC permissible venues o Misappropriation Theory: Under misappropriation theory. United States v. Rule 10b-5 liability arises when a person trades on confidential information in breach of a duty owed to the source of the information. even if the source is a complete stranger to the traded securities. O’Hagan: • Partner in a law firm purchased stock in company that used the law firm to make a tender offer • Lower court convicted him of misappropriating information • Supreme Court: o Confirmed misappropriation theory: The unauthorized use of a deceptive device under §10 In connection with securities trading Is a violation Rule 14e-3 • One violates the rule if he trades on the basis of material non-public information concerning a pending tender offer that he knows or has reason to know has been acquired directly or indirectly from an insider of the offerer or issuer o Without regard as to whether the trader owes a pre-existing fiduciary duty to the information’s source • There is no need to prove that the tipper breached a fiduciary duty for a benefit under 14e-3
individual can’t make a “matching trade” within 6 months that creates a profit for the individual o Must invest for longer than 6 months or buy-sell at different volumes of stock Applies to trading in equity securities Imposes automatic. strict liability on qualifying officers. non-public information acquired from a family member that was an insider • Can’t claim information was inadvertently leaked Also. prevents persons who have a history or practice of sharing confidences (both business and personal) so the recipient had reason to know the communicator expected the recipient to maintain the information’s confidentiality Doesn’t cover people that are just living together o Use / Possession Distinction– Rule 10b-5(1) (486) Prevents people who are “aware” of material nonpublic information from buying stocks on that basis Forecloses potential problems when individuals “know” of information. and 10-percent shareholders who make a profit in short-swing transactions within a 6month period
. directors. and authorizes the corporation to recover from these insiders any profits made on stock purchases and sales in a 6-month window • Basically.o Family and Business Relationships – Rule 10b-5(2) (497) Prevents family members from trading on material. but don’t necessarily “use” the information in their decision Auto-trades would get around this even awareness is trumped because the transaction is occurring outside of the individual’s capacity o Damages in a Tipping Case: Elkind v. or tippee’s liability is capped at the amount of profit made or loss avoided o Section 16(b) (Short-Swing Transactions): Requires specified traders to report their trading in their company’s securities. tipper. Liggett: • Disgorgement: o The trader.
A 16(b) violation is not a “crime”. Cumulative Voting Pass fundamental corporate changes • Usually limited to ratifying or vetoing the board’s recommendation 34
. not just the majority of those who choose to vote) o Plays a big role when only the incumbent is on the ballot – under plurality standard. it just creates liability to the corporation • Loss avoided is the same thing as profit earned • The offending director or 10-percent shareholder has to disgorge profits to the corporation • The 10-percent shareholder: o The application of the rule requires that the shareholder be a 10%+ shareholder on every leg of the transaction • If you have a sub-10% shareholder that has “deputized” an individual on the board. you may be held liable for 16b disgorgement Mechanical Application: • You can actually go “into the whole” if you make multiple transactions and accrue a loss (example from E&E book) • Always go “lowest in. highest out” • Always “zero out” as many of the shares as possible
• Overview: o Purpose of Shareholder Voting (when is a vote typically required?): Elect directors to the board • Plurality has been the standard in the past (majority of the shareholders that participate in the vote) • The majority standard is becoming more prevalent because it gives shareholders a greater voice (need an actual majority of the shareholders. a single vote would be sufficient to get the director back on the board • SEE BELOW – Straight v.
Committee was able to overcome Dow’s contention that this was a political proposal. stockholders have no power of initiative • Some statutes authorize corporation to require a supermajority vote to enact a change Initiate limited changes to the corporate governance structure • Amendments to bylaws • Amendment of Articles of Incorporation (limited number of statutes) Shareholder Proposals: • Rule 14a-8 • Allows the shareholder to attach a proposal to the corporation’s own proxy statement o A good avenue to trigger negotiations with the company o Shareholders can only recommend actions by the board – cannot try to dictate • There are several exclusions to the rule that allow a corporation to deny a stockholder addition to the proxy statement: o If the proposal is political in nature or has a social agenda o If the proposal is overly broad o If the proposal effects less than 5% of the corporation’s business • The board cannot deny proposals that are primarily related to corporate success however: o Cracker Barrel – not hiring homosexuals is bad for public relations and bad for business. Court also disallowed subsequent denial of a proposal as too broad.Generally. This is such a significant issue in society that the shareholders should have the right to say something about it o Medical Committee – selling napalm is bad for business. saying that Dow was effectively trying to have it both ways o Veto Power o Voting belongs to the shareholders:
they hold large stakes in a significant number of companies – creates a problem for the institutional investor to be present at all corporate functions and speak on issues 36
. no one can take over control of a corporation without first acquiring the right to elect a majority of the board of directors Critics have long claimed that shareholder voting fails to properly hold individuals accountable in corporations • Low participation rates • Normally. ownership is so varied that working control of a corporation can be maintained by a small minority of the shareholders isn’t shareholder voting like a democracy? Proxies: • Corporation solicits proxies at corporation’s expense • Individuals must fund their own efforts • Individuals may feel that they aren’t informed enough and therefore opt to side with management – regardless of the circumstances Rational Apathy Problem • It’s too much work for a single shareholder or group of shareholders to act against management Free Rider Problem • Shareholder assuming that another shareholder will effect the change needed at a corporation • Potentially allows a shareholder to take on no additional effort and expense to get the desired result while another expends time and money • Will freeze action by all parties everyone is assuming someone else will do the work Institutional Investor Problem: • Not retail investors • These investors hold significant stakes in a company • However.
(DE allows bondholders to vote as well – if the corporation adds it to the bylaws) Shareholders have paid for the privilege to vote – not employees or officers Ultimately.
more likely to stick around and wage a fight • Mutual Funds – more willing to sell and reinvest elsewhere o Mechanics of Shareholder Meetings: Types of Meetings: • Annual o Corporations are required to have an annual meeting o Hilton v. less than 60) o Must contain enough information to make a decision o Record Date – must be the owner of the stock as of the record date to vote on the matter provided in the notice Quorum: • Must be quorum to be a valid meeting 37
. the corporation does not have to permit for a shareholder-called meeting Colorado: • 10% of the shareholders can always call a meeting Notice: • Stockholders must receive appropriate notice o Must be timely (more than 10 days. ITT Corp. Meeting does not have to be exactly every 12 months Statutes can determine the window of time a corporation has to have its annual meeting “Annual” meeting really means “regular” meeting • Special Meetings: o Directors can call special meetings o Usually called to vote on an important issue that cannot wait until the annual meeting o When can shareholders call a meeting? Delaware: • Look to the charter and bylaws • Default state.effectively • Pension Funds – more active.
dissolution) • Simple Majority Vote: o If the statute does not require an absolute majority. DE § 228 does not necessarily prevent a corporation from adopting bylaws that would provide some structure around consent initiatives o Judicial Oversight: Schnell v. and statute allow the board of directors to change the date of the election does not mean that the board can do it simply to increase their chances of
. one vote gets him on the board Action by Consent: • Under most statutes. shareholders can act without a meeting by giving their written consent for an action • The appropriate majority must still be obtained (what about a simple majority vote?) • Datapoint Corp v.Appearance in person or by proxy: • If you can’t be there in person. Chris-Craft Industries: • The fact that the charter. you must sign a valid proxy statement giving another entity the right to cast your vote in a specific manner Types of Voting: • Majority Vote: o Many statutes require a majority vote of all the outstanding shares (not just the shares that are present) to pass board initiated transactions (mergers. sale of assets. bylaws. Plaza Securities Co (DE) o Board enacted bylaws that limited the effect of a shareholder consent initiative in the faece of a hostile consent proposal by a shareholder o Court struck down bylaw o However. it likely requires a simple majority – a majority of the votes that are present • Plurality Vote: o Used in director elections o The director gets elected if he gets more votes than the next guy If there is only one candidate.
a judge will not interject and determine the proper time for a shareholder meeting or director election during an annual or special meeting Hilton Hotels v. basically any decision made by a board in the future could be seen as judiciable MM Companies v. Liquid Audio (NEED TO DO WORK HERE) • Blausius Standard: o Unless the board can articulate a compelling justification for its action.
winning a contested election o This violates the fiduciary duties of the board • Under normal circumstances. Grace • Individual family owns the majority of the shares in a company and desires to change the corporate charter and bylaws o The changes would essentially give the family permanent control over the company • Minority shareholders protested the change • At the time of the proposal. courts intervene to protect established principles of democracy o Applies when the primary purpose of the board’s action is to impede shareholder’s opportunity to vote • Reconciling Blausius with Unocal: o Assess Blausius first – is there a
. there is no threat to management • Court finds that the decision only needs to pass the business judgment test and easily accomplishes this o This is not a situation where the board needs to meet the compelling justification standard (Blausius) – since there is no threat o If the court required the compelling justification standard here. ITT • ITT restructured itself into three different corporations • Stroud v.
a shareholder holding a majority of the shares can elect the entire board of directors If you have 100 shares and there are 3 open positions.compelling justification for the board’s actions o If there is a compelling justification for the board’s actions – Apply Unocal / Unitrin There must be a threat The reaction to the threat must be reasonable • It cannot be coercive or preclusive o Director Elections: State statutes don’t require that directors own shares. you cast 3 votes of 100 shares • Cumulative Voting (598): o Allows shareholders to accumulate all of their votes and allocate them to the director they choose (or directors) Increases the chance that a minority shareholder will get a director on the board over a majority shareholder’s vote o Shareholders must be careful to allocate votes such that they don’t accidently provide other shareholders an edge Applies to both majority and minority shareholders o Calculations: Number of shares required = • Number of shares voting / Number of Directors to be
. but only that they be individuals and meet qualifications outlined by the corporation’s bylaws and charter Voting Methods: • Straight Voting: o The top vote-getters are elected to the board for the open vacancies o Shareholders vote their shares for each open directorship Therefore.
eliminate the staggered board. shareholders can amend the organization of the corporation. CA.elected + 1 o Director Removal and Vacancies: Common law: • Directors could only be removed for cause • Commentators criticized this notion – why should a director have some sort of vested interest in their directorship? Modern: • Slowly adopted by more jurisdictions: o Directors may be removed without cause if the certificate or bylaw adopted by the shareholders provides. and then immediately remove directors without cause If the corporation has cumulative voting a director can only be removed for cause unless the entire board is going to be removed Directors have no inherent ability to remove another director from the board Vacancies: • Common law: o Shareholders were required to fill director vacancies • Statutory: o Vacancies can be filled by the board Unless the vacancy was caused by
. o DE. and the bylaws are silent o DE allows corporations to remove directors through written consent However there must be unanimous consent in this instance o DE caveats: If the board is staggered. the director can only be removed for cause • However. and Revised Model Business Corporation Act go further and allow for removal even if the cert.
a controlling shareholder would oppose transactions which could be determined by the board of directors to be in the best interest of the shareholders – are impermissible • When is coercion permissible? o If a controlling group of shareholders asks for something specific. as long as the certificate of incorporation provides for the different classes of shares • It is more restrictive if the corporation attempts to institute new classes of shares after incorporation • Corporate boards cannot enact stock classifications after incorporation o Unless the plan is enacted after a shareholder vote w/ full disclosure o However. a shareholder vote approving the measure is invalid if it was only approved through coercion • Dual classification can be easily obtained at incorporation – there is no coercion or “sneaky dealings” on the part of the board at that point State Regulations: • Lacos Land v. but does not threaten retribution if they don’t get their way – the court will likely find this to be permissible o Street Name Ownership: Individuals don’t own a “paper” stock certificate anymore – brokerage firms possess the stock certificates and the shareholders own shares
. one vote”? • No.a removal without cause o Staggered Boards: The board is classified into groups of directors – each with multiple year terms that expire at different times This can serve as a protective measure – an activist shareholder cannot replace the entire board in one year o One Share / One Vote: Do you have to have “one share. Arden Group (DE) o Implied threats that unless the proposed amendments were authorized.
in turn. without the underlying economic interest (basically. Carney: • Company loaned money to an individual to pay off debt so that the company could merge with another and the individual would not face adverse tax consequences • Court: o Transfers of voting rights. pass owner ship of that portion down to the individual consumer (shareholder) • The DTC knows which brokerages own how many shares of a particular company. Unless the object or purpose is to defraud or in some way disenfranchise the other stockholders o Since this action was done in the open and fully disclosed to shareholders.
underneath the brokerage firm In the early 70’s the Depository Trust Company was formed and the DTC holds global certificates for all publically traded companies • Brokerage firms have equitable interests in these global certificates and they. selling the vote) is not necessarily illegal. courts have cautiously started to accept the premise of vote-buying • Courts will still look closely for fraud or disenfranchisement (anything that disparately impacts other shareholders) Schreiber v. there is no fraud o Vote buying is so subject to 43
. but the DTC does not know who personally owns the stocks o This prevents the DTC from being able to produce a list of stockholders for a particular company (for things like a proxy contest) o It can be difficult for the corporation as well as individuals that wish to commence with a contest What is the process for individuals to get ahold of a stockholder list? Buying: Historically vote buying was per-se illegal Over time.
however. or an outside group Proxy Contest Expenses: • Management traditionally charges the expenses of a proxy statement and contest to the corporation. a group of shareholders.) • The format of the proxy card is outlined in federal regulations • The disclosure and the proxy card must be prefiled with the SEC for review • False and misleading proxy solicitations are prohibited Proxy statements will either be sent out by management. Fairchild Engine: o The expenses of a proxy contest can be reimbursed o The incumbent management can reimburse themselves when they win a proxy contest o Challengers: Can be reimbursed if they win a proxy contest If they do not win the contest. there will not be any reimbursement – the corporation is under no obligation to reimburse a
. while non-management groups must fund the effort themselves • Why don’t challengers get reimbursed? o If management had to reimburse any challenger.disenfranchisement and fraud. there would be the opportunity for a minority shareholder who has minimal chance of success to charge the corporation with significant costs o Forcing challengers to pay their own way ensures that only valid challenges will be brought • Rosenfeld v. that it will always be subject to the intrinsic fairness test o Proxy Contests: Requirements: • A disclosure must accompany every proxy solicitation (contents regulated by fed.
only the last card signed should count as the “shareholder’s vote” • State statutes authorize corporations to assign an “election inspector” to cut off potential controversies. giving managers the discretion to deploy that expertise on behalf of shareholders also gives managers discretion to favor their own interests at the expense of the shareholders o Takeovers and acquisitions illustrate this agency problem: Shareholders are charged with making the final decision of whether to merge or purchase a large asset. however. and Control Transactions
• Policy Considerations: o Governance of Corporations poses a fundamental agency problem Shareholders delegate decisionmaking for certain transactions to management because managers have greater expertise. Takeovers. Duties include: o Ascertaining the number of shares outstanding o Determining the shares represented at the meting and the validity of all proxies and ballots o Counting all votes and ballots o Producing and retaining a record of the determinations and challenges o Certifying the determinations and their count of all votes and ballots
challenger Election Inspectors: • Individual shareholders can sign multiple proxy cards during a proxy solicitation – it is permissible to flip-flop sides during the solicitation process • However. but this requires expertise that usually resides with the managers of the corporation There is a constant threat of conflict of interest for management because what is “best for management” may not be best for the shareholder – how can the shareholder be sure that management 45
where management opposes the proposed transaction (tender offers and proxy contests are normally used in hostile takeovers) o There are federal regulations that can come into play with each of these strategies Defensive Tactics of Targets: o Many tactics are implemented prior to the arrival of a hostile bidder (these all require shareholder approval w/o evidence of coercion or fraud): Staggered Boards: • Requires a shareholder vote • Draws out the length of time required to initiate a takeover through proxy elections • In DE removal on a staggered board is only for cause Majority voting (or super majority voting ) provisions: • Requires the hostile bidder to truly get a majority of shareholders on board Article Provisions: • Fair price in a freeze-out merger Recapitalization: • Providing two classes of shares where one class is given significant voting rights in lieu of good dividends o Tactics that can be implemented during a takeover bid: Restructure of the target to make it less desirable Granting of an option to sell off a crown jewel Selling a block of shares to a “white knight” that will side with management Increasing debt through various means – makes the target less desirable. and may prevent the hostile 46
will bring the best options forward? Takeover Strategy: o There are several options for initiating a takeover of a corporation: Merger Sale of Assets (the company can sell itself off) Tender offer Proxy Contest o Some options are considered “friendly” in that they are done with management’s approval (mergers and sales of assets will typically be the result of a friendly takeover transaction) o Others are more conducive to a hostile takeover.
the rights become exercisable and permit shareholders to purchase large amounts of shares at a discounted price (in a flip-in scenario.bidder from using the target as collateral once a takeover is achieved Take the corporation private – usually through a selfleveraged buyout o Poison Pills: The most significant of the defensive tactics Has the ability to thwart an unfriendly takeover and give control to the target directors Do not require a shareholder vote! Basic Structure: • Corporation issues to shareholders a class of convertible preferred stock that is originally priced well outside market levels so that they are effectively useless • Upon a triggering activity: o A hostile bidder acquires a certain percentage of the corporation. or o A hostile bidder makes a tender offer for a certain percentage of the corporation • The board then has a specific amount of time to redeem (nullify) the convertible shares (which essentially would let the offer go through) • If the board does not redeem. in a flip-over scenario. shareholders buy the acquirer’s stock) o This significantly increases the costs for the acquirer • The reasoning behind the pill’s issuance is to get the acquirer to talk to the board before commencing with an offer Types of Poison Pills: • Flip-in: o Entitles the holder to buy discounted target securities and excludes the acquirer from participating • Flip-over: o Entitles the holder to buy discounted
. shareholders buy the target’s stock. the convertible shares become “poison” and if the hostile offeror makes further moves for the company.
acquirer securities • Dead-hand: o Response to a combined tender offer/proxy contest o Seeks to block the redemption of the poison pill by directors who were not in office at the time of its adoption o Invalidated in DE o Can only be redeemed by directors in office at the time of its adoption – or their nominees o Following successful proxy fight. but must expire • Slow-hand: o Like the Dead-hand pill. the pill cannot be redeemed. what should the standard of review be when shareholders take them to court? Business Judgement Standard – doesn’t work because it would almost certainly require the court to stand by the director’s decision 100% of the time Intrinsic Fairness – isn’t called for because theoretically. but just slows the redemption by a new director by a certain period of time (normally 6 months) o Invalidated in DE Shareholder Response: • Shareholders – particularly institutional shareholders – have come to dislike poison pills • Amendment of bylaws to prevent poison pill from being adopted without shareholder approval • Amendment of bylaws to do away with implemented poison pill. immediately. Mathes Board of directors made a “greenmail” offer to a stockholder (offering premium over the current stock
. not at expiration date
State Law: o All DE unless otherwise specified o When a target company’s management and directors institute actions to defend the corporation from a hostile takeover. management is applying its skills to the situation and should be given some deference Thus the Unocal test (below) o Cheff v.
value) in order to keep the stockholder from making a hostile tender offer Minority shareholders brought suit saying the board did not have the right to take on the substantial debt necessary to buyback the shares Court opted not to apply the business judgment rule or the duty of loyalty standard: • Court shifted the burden to the defendant directors to show whether there were reasonable grounds to believe a danger to corporate policy or effectiveness existed • Directors were able to satisfy this burden the potential hostile bidder had a bad record of previous business decisions o Unocal Corp. Unocal issued a significant amount of debt and ended up being heavily leveraged (which worked against Mesa as Mesa would need to use Unocal’s assets to cover its debt after a takeover) Mesa challenged Unocal’s self-tender as beyond the power of the board and a breach of fiduciary duty Court: • When directors implement a defensive tactic there arises an omnipresent specter that a board may be acting primarily in its own interests. it must be reasonable in relation to the threat posed • The directors must analyze the nature of the takeover bid and its effect on the corporation and determine that harm will take place Test: • The defensive board must prove: o That it had reasonable grounds for believing that a danger to corporate policy and effectiveness existed (the 49
. Mesa Petroleum Mesa owned a 13% portion of Unocal and commenced with a two-tier takeover (first acquiring 51% of the company and then engaging in a freezeout merger) Unocal commenced with a stock buy-back in an effort to prevent Mesa from taking over control of the company – in order to do this. v. rather than in those of the corporation or its shareholders • If a defensive measure is to fall under the business judgment rule.
Time Time negotiated a friendly merger with Warner to pursue a plan of strategic expansion Paramount entered and offered Time up to $200 per share in a takeover bid. once a company enters into Revlon mode. and o The defensive tactic was reasonable to the threat posed (the response) • Only then will the court apply the business judgment rule to the board’s decision o Revlon v. those concerns are only valid if they are rationally related to getting shareholders the best price Exception: • When the bidder is a “strategic buyer” the board does not have to make as thorough an “attempt” to canvas the market for the best price o Strategic buyers may be better for the stockholder in the long run o Paramount v. and therefore has effectively announced that it is for sale • While Unocal suggests that directors can be concerned with other corporate interests during a takeover. lock-ups are permitted under DE law when their adoption is untainted by director interest Court: • Revlon mode: o A company enters into Revlon mode when it has announced that it is for sale Here the target found a white knight. MacAndrews A company made a hostile attempt for Revlon and Revlon took defensive steps to rebut the hostile takeover.threat). eventually Revlon found a white knight to buy the corporation (instead of the hostile) Friendly merger Lock-ups: • “no-shop” provisions • crown jewel sale • cancellation fee • In the court’s view. and Time directors feared
it would be a different scenario Unocal: • Using the two-part test: o The court found that there was a “threat” in that Paramount’s offer was designed to confuse shareholders and prevent them from adequately considering the Warner merger plan o The directors were therefore allowed to react with a proportionate response – which was to protect the pre-existing plan • The court decided that determining which was the better deal for the shareholders was a question for the directors in this case – and therefore. or stockholders did not approve the transaction. Time did the purchasing • If Time was being “purchased” by Warner.that shareholders would reject the merger with Warner in favor of Paramount Time then switched its agreement around and purchased 51% of Warner (which did not require shareholder approval) and then effected the merger with Warner Paramount brought both Revlon and Unocal arguments against Time Under Time – there does not appear to be a general obligationto sell a corporation simply because there happened to be a substantial premium in cash offered to shareholders in a tender offer when such a sale would upset a business plan Unlike Revlon. the directors did not violate their duty o Paramount v. or Paramount’s directors recommended a 51
. there was no planned breakup of Time. QVC Paramount agreed to be acquired by Viacom in a friendly acquisition with a no-shop provision • If Paramount terminated the agreement. just the merger Revlon: • Time’s negotiations with Warner did not put the company up for sale (a dissolution or breakup of the company was not inevitable) such that it entered Revlon mode – and in the end.
the board had the obligation to look for the best deal possible for shareholders o Unitrin v. in response.competing transaction – Viacom would receive $100 million termination fee and the option to buy 24 million Paramount shares Paramount shareholders would own shares of the new merged company. both companies were public companies with widely dispersed shareholder bases • In this case. American General Corp. after the merger. but the controlling shareholder would still be Sumner Redstone (70%) QVC made an offer for Paramount but Paramount viewed the merger with Viacom as a better long-term fit for the company and shareholders • Basically structured the same as the Time deal QVC sued to enjoin Viacom’s offer and Paramount’s use of defensive tactics Court: • The Time decision did not apply and Revlon was triggered in this case because there would be a change of control when the merger took effect • In the Time case. American General instigated a two-step unsolicited bid to replace the incumbent Unitrin board and then make a tender offer Unitrin. implemented a repurchase program whereby the corporation repurchased shares on the open market. then the court should use enhanced scrutiny to determine whether the target board adequately examined all proposals and sought the best price for shareholders Essentially. there would be a controlling shareholder and the Paramount shareholders would effectively be minority shareholders • Rule: o If the transaction will involve the target shareholders turning into minority shareholders. in QVC the court has said that Paramount put itself up for sale because the effect was going to be a significant change for shareholders – not unlike a cash sale • Therefore. but directors did not take 52
the reaction of the target board was not disproportionate (and the court said that the bid was a low-ball bid) o The buy-out plan probably helped Unitrin buy out short-term speculators (arbitragers) who just wanted to get in on the merger profits o OmniCare v. in addition to Unitrin’s poison pill and the supermajority requirement made any tender offer basically impossible Court: • Reviewed the repurchase program under the Unocal Test: o Is there a threat to corporate policy? o Was the reaction to the threat proportionate? • The court determined that the buy-back program did not conclusively prevent AmGen from winning a proxy contest or eventually winning support for a merger – the price would simply have to be right • Therefore.advantage of the offer – the result was that the directors ended up with a larger percentage of the outstanding votes and were able to withstand a merger proposal which needed a supermajority of the outstanding shares AmGen argued that the buy-back plan. NCS Healthcare NCS is insolvent and looking for a buyer Omnicare approaches first and offers a fire sale for the company – shareholders will get very little if anything NCS continues to look around and Genesis agrees to purchase for a reasonable share price – but only in a lock-up agreement • Agreement required that the merger agreement be brought before the shareholders • Agreement also required that the two major shareholders sign irrevocable proxy agreements to vote for the merger Omnicare comes back around and makes a better deal than Genesis and the board may want to side with Omnicare now • However. the effect of a change in sides is null. the merger with Genesis is essentially locked 53
Carroll Carroll family owns a controlling share in Katy corporation and makes a move to take the company private by making a tender offer to shareholders Outsider makes a higher offer for shares of the company and wants the Katy board to exercise an
. had to share the premium received for his shares Premium sharing (controlling block of shareholders) • Generally. Feldmann Newport Steel case Fiduciary obligations of controlling shareholders Feldmann owned 37% of Newport Steel and sold his shares for a premium • This was during the Korean War and there were price controls on steel • Feldmann had created a way around the price controls (the Feldmann Plan) • The purchaser of the stocks wanted to get ahold of Newport’s steel without the Feldmann Plan process.down Court: • Unocal Analysis: o Is there a threat to corporate policy? o Are the actions taken by the board proportionate in the face of that threat? New element (Unitrin) – Are the actions coercive or preclusive? • Here. or to receive the best offer o Perlman v. a controlling shareholder is under no obligation to share the premium his controlling block of shares commands o Mendel v. in this case. the board’s actions were entirely preclusive because there was no option for Omnicare to present a better offer once the agreement with Genesis was signed – the terms of the agreement took any option away from the shareholders to make a decision. which made the steel more expensive to the purchaser Court: • Feldmann violated a fiduciary duty to the company by selling the ability to charge profits through the Feldmann plan • The court held that Feldmann.
the Outsider is attempting to gain controlling stock in the company • The Outsider’s offer should be worth more because he is purchasing controlling stock in the company o A controlling block is worth more than a non-controlling block Takeaways: • If there is a control group that owns more than 50% then the fact that an outsider responds to the freezeout by offering to buy the corporation for a higher price does not mean that the control group has to sell or give up the freezeout Digex Shareholders Litigation Intermedia owns 60% of Digex and the public owns 40% Worldcom wants control of Digex • Two options: o Purchase Digex o Purchase Intermedia (and gain the 60% contol of Digex) Worldcom decides to purchase Intermedia • Intermedia and Worldcom asked the Digex board to take affirmative action to facilitate the sale of Intermedia to Worldcom • If Worldcom was purchasing Digex. the Carroll family already owns controlling stock of the company and is simply trying to gain the rest of the shares of the company • In the second case. it would be up to the board to throw up some road-blocks and insure the best price for shareholders • That obligation does not go away just because Worldcom is purchasing Intermedia o Digex directors should have critically
o In Re
approved option to issue new shares that would be purchased by the outsider (and would take the Carroll family out of control of the company) Mendel and other minority shareholders brought suit to force the board to issue the shares giving the shareholders a better offer Court: • The plaintiffs are comparing apples to oranges • In the first case.
a new 20 day window is triggered o The acquirer has to treat all target shareholders the same – must deal equally with everyone o The acquirer has to maintain the same price for all target shareholders o Target shareholders have the right to withdraw during the 20-day window Considerations: o Acquirers typically want to get the largest share of stock 56
. then the board should have refused to recommend
The Williams Act:
• Overview: o Amends the 1934 Securities Exchange Act o Designed to regulate stock purchases that effect corporate control o Mandates disclosure for stock accumulations of more than 5% of a target’s equity securities o Mandates disclosure by anyone who makes a tender offer o Provides for enforcement of these Schedule 13d Disclosure: o Disclosures must include: The acquirer’s identity and background The source and amount of funds for making the purchases # of target’s shares held by the acquirer the acquirer’s purposes for the acquisition and his intentions with respect to the target o Beneficial ownership means that you have share voting or investment control of a stock o Beneficial ownership also relates to group ownership – if you agree to act together with another shareholder with respect to your shares – you are deemed to be a group and must disclose any 5%+ ownership in a corporation o Disclosure rules are designed to prevent a “secret” accumulation and takeover attempt Section 14d and 14e: o Applies to tender offers o The acquirer has to hold the tender offer open for at least 20 business days If the acquirer changes the terms of the tender offer.assessed the proposed deal to make sure it was the best possible option for Digex shareholders – and if not.
there is no duty to disclose (unless one of the funds reaches disclosure levels on its own) However. the stock price is likely to rise significantly Will likely attempt to get the largest share possible before the 10-day reporting requirement arrives o Hedge funds often work in similar manners (Wolfpack situation): Purchase a measurable portion of stock in a company. but left the window for consideration open for a short period of time • The court concluded that there had been a public solicitation in this case • Wellman Factors for a Tender Offer: o An active widespread solicitation of public shareholders o Solicitation of a substantial percentage of the target’s stock o The offer of a premium price o Non-negotiable terms o Conditioning the offer on the acquisition of a specified number of shares o The offer being open for a limited period of time o Pressure on the shareholder to tender o Substantial publicity concerning the offer
• Freeze-out Mergers:
. then there is a duty to disclose if the group reaches the appropriate levels o Acquirers will try to avoid the statutory disclosure requirements and the statutory tender requirements: Wellman v. and sell at a profit If hedge funds pursue the same company with the same motive. agitate so that the stock price rises. but are not acting in conjunction.possible before word leaks about an acquisition attempt – once word leaks. Dickinson: • Acquirer made 39 simultaneous telephone calls to large holders and offered to buy their stock at a substantial premium. if the funds formally agree to work together for the common goal of spiking a stock price.
Under Pure Resources. making it the sole shareholder This is different than a short-form merger o Court Review: The court will ask whether the majority shareholder offered both: Fair Dealing and a Fair Price (This is the ENTIRE FAIRNESS STANDARD) o Purchasers typically don’t like the increased rigor of the entire fairness standard – one way to avoid this test is to utilize a tender offer rather than a freeze-out merger If the purchaser can acquire more than 90% of the shares. then it can commence with a short-form merger. it is typically necessary to make a freeze-out tender offer first. the court will: o Evaluate the corporation and determine whether the offer to the remaining shareholders is legitimate (This is the APPRASIAL METHOD) To get to a short-form merger application.•
o Controlling shareholder and the board of directors (this is often a parent subsidiary relationship) agree to a merger where minority shareholders will get cash for their shares and the majority shareholder will retain its shares. that tender offer must meet the test for a fair price: • In re Pure Resources Inc. which will only be subject to the appraisal standard on review (see below) Long Form and Short Form Mergers: o Long Form: Must be approved by the board and then the shareholders This is a traditional merger o Short Form: There is a majority shareholder that possesses 90%+ of the corporation There is no vote required to effect a merger – the majority shareholder can simply buy out the remaining shareholders Court: • In determining validity of a short-form merger. o The essential duty of the court is to ensure that majority shareholders don’t bully around minority shareholders
there must be an independent committee or at least a majority of the minority to approve the deal • However. Kahn will issue a tender offer to shareholders o Court: Looks to entire fairness: • To review a deal proposal.o Test for tender offer: The tender offer must be subject to non-waivable majority of the minority tender condition The controlling stockholder must promise to consummate a prompt short-form merger at the same price if it gets 90%+ of the outstanding shares through the tender offer The controlling stockholder cannot make any threats to the minority stockholders • • Weinberger v. the independent committee must be effective and cannot be beholden to the purchaser
. (fair dealing case) o Company is a significant shareholder in UOP and decides to engage in a tender offer and eventually a merger o Company has some individuals on UOP’s board (this makes them conflicted when dealing with the transaction) UOP also did not set up an independent committee to review the proposal from Company o Court: Utilized entire fairness standard: • Was there both fair dealing and a fair price? • Court says no to both: • There could not be fair dealing because of the conflict of interest and the haste with which the deal was put together • Therefore. there is a good chance that this is not a fair price Kahn v. UOP. Lynch Communications (fair dealing case) o Kahn made a merger offer to Lynch o Kahn owns 43% of the company o Kahn threatens the board that if the merger offer proposed to the board is not accepted. Inc.
Court find’s Kahn’s offer to coercive Court did not look to business judgment review. persuasive evidence of fair price under recognized valuation standards
Partnerships. Co of Minnesota FD had two partners and entered into a contract with Title Ins. b/c the controlling shareholder has inherent potential to coerce the shareholder vote for the merger Kahn II (fair price case) o Fair value can be based on opinions of the parent’s investment banker. Limited Partnerships. Title Ins. the parent must come forward with credible. FD added another partner FD later had an issue and filed for an insurance claim which Title Ins. denied because the addition of a new partner created a new entity – which Title was not
.Unlimited. even though the subsidiary’s committee has received opinions of higher value from other investment bankers o Court: When parent bears the burden of showing entire fairness. LLCs
General Partnership Nature Formation Liability Fiduciary Duties ? Unintentionally Joint & Several Owed to all partners.Limited Same LLC Entity File w/ State Limited Same
Partnerships o Two or more individuals carry on a business together as coowners o A partnership is not a tax-paying entity Income and losses from the partnership are treated as income or losses of the partners individually o Fairway Development v. can be varied Limited Partnership Entity File w/ State GP . LP .
under contract with Court: • Agreed with Title This decision created a lot of uncertainty and was later overturned statutorily in the RUPA (I think it still stands under the UPA) o Voland v. Sweet Sweet worked for Vohland Over the course of time became a valued employee and moved into a different compensation structure At points. it can exist based solely on circumstances o Fiduciary Duties: Meinhard v. Salmon • Salmon managed a property leased from Gerry • Meinhard was an investor with Salmon on the project • Salmon re-signed a lease with Gerry but did not included Meinhard • Meinhard sued • Takeaway: o Fiduciary duties are owed to all partners Limited Partnerships o Entirely a creation of statute o Serves two aims: Limited liability for investors Avoidance of double taxation for partners o General Partner: Same as a partnership – unlimited liability o Limited Partner: Not personally liable directly or indirectly by way of contribution for an obligation of the limited partnership – even if the limited partner participates in management and control of the partnership
. Sweet’s 20% commission was partially invested back into the business before Sweet received his take-home pay Sweet brought action that he was a partner to the business • Court agreed Takeaway: • A partnership can be formed unintentionally • Even if both partners are intent on not creating a partnership.
There will be an operating agreement. and you can come up with any kind of operating structure you want The LLC is more a "creature of contract" than the other types of partnerships . that the limited partner is the general partner ULPA: • Limited partner will not be liable as a general partner unless he takes part in the control of the business o Gotham Partners v.looks more like a partnership Manager-Managed . Hallwood Realty Partners The Partnership has essentially adopted the entire fairness test through bylaws – even though the entire fairness test is not necessarily applicable to the situation Based on this case: • DE has said that it is ok to not only restrict fiduciary duties. the implied covenant of good faith and fair dealing still exists and will be followed LLC • • • • • Member-Managed .the general partnership is more a creation of common law Westec v. files paperwork for a limited partnership.looks more like a corporate form In all cases . but in good faith. Lanham and Preferred Income Investors o
. will be treated as a limited partner o Liability: RULPA: • Limited partner is liable only to persons who transact business with the limited partnership reasonably believing based upon the limited partner’s conduct.o Formation: Can only be formed by filing a certificate of limited partnership in the office of the secretary of state Under RULPA – a partner that erroneously. but a limited partnership can also eliminate fiduciary duties • However.