Chapter 37 Corporate Governance and the Sarbanes-Oxley Act

Shareholders  Own the corporation  Not agents of the corporation  Cannot bind the corporation to contracts  Have right to vote on fundamental changes in the corporation Copyright © 2013 Pearson Education, Inc. Publishing as Prentice Hall. 37-2

Shareholder Meetings  Annual shareholders’ meeting: Held by the corporation to elect directors and to vote on other matters  Special shareholders’ meetings: May be called to consider and vote on important or emergency issues, such as a proposed merger or amending the articles of incorporation Copyright © 2013 Pearson Education, Inc. Publishing as Prentice Hall. 37-3

Notice of a Shareholders’ Meeting  Corporation is required to give the shareholders written notice of the place, day, and time of annual and special meetings  A proxy  May be authorized to vote on a shareholder’s behalf  May be directed exactly how to vote the shares  May be authorized to vote the shares at his or her discretion Copyright © 2013 Pearson Education, Inc. Publishing as Prentice Hall. 37-4

Voting Requirements  Shareholders who own stock as of a set date are allowed to vote at a shareholders’ meeting  Shareholders’ list—contains the names and addresses of the shareholders as of the record date and the class and number of shares owned by each shareholder  Quorum to hold a meeting of the shareholders: The required number of shares that must be represented in person or by proxy to hold a shareholders’ meeting Copyright © 2013 Pearson Education, Inc. Publishing as Prentice Hall. 37-5

Voting for Election of Directors  Straight (Noncumulative) Voting: A system in which each shareholder votes the number of shares he or she owns on candidates for each of the positions open  Cumulative Voting: A system in which a shareholder can accumulate all of his or her votes and vote them all for one candidate or split them among several candidates Copyright © 2013 Pearson Education, Inc. Publishing as Prentice Hall. 37-6

Supramajority Voting Requirement  Articles of incorporation or bylaws may require more than a majority of shares  To constitute a quorum  For votes for mergers  For consolidation, or other important matter Copyright © 2013 Pearson Education, Inc. Publishing as Prentice Hall. 37-7

Voting Agreements  Shareholders agree in advance as to how their shares will be voted  Voting trusts: An arrangement in which the shareholders transfer their stock certificates to a trustee who is empowered to vote the shares  Shareholder voting agreements: An agreement between two or more shareholders that stipulates how they will vote their shares Copyright © 2013 Pearson Education, Inc. Publishing as Prentice Hall. 37-8

Restrictions on the Sale of Shares  Right of first refusal: An agreement that requires a selling shareholder to offer his or her shares for sale to the other parties to the agreement before selling them to anyone else  Buy-and-sell agreement: An agreement that requires selling shareholders to sell their shares to the other shareholders or to the corporation at the price specified in the agreement Copyright © 2013 Pearson Education, Inc. Publishing as Prentice Hall. 37-9

Preemptive Rights  Rights that give existing shareholders the option of subscribing to new shares being issued in proportion to their current ownership interests  Granted by the articles of incorporation  Failure to exercise preemptive right—shares can be sold to anyone Copyright © 2013 Pearson Education, Inc. Publishing as Prentice Hall

Dividends  Distribution of profits of the corporation to shareholders  Paid at the discretion of the board of directors  Stock dividend: Additional shares of stock distributed as a dividend  Distributed in proportion to the existing ownership interests of shareholders  A shareholder’s proportionate ownership interest is not increased Copyright © 2013 Pearson Education, Inc. Publishing as Prentice Hall

Derivative Lawsuits  A lawsuit a shareholder brings against an offending party on behalf of a corporation when the corporation fails to bring the lawsuit  Court may dismiss if the lawsuit is not in best interests of corporation  Any award goes to corporate treasury  Corporation pays shareholder’s expenses Copyright © 2013 Pearson Education, Inc. Publishing as Prentice Hall

Piercing the Corporate Veil  If a shareholder dominates a corporation and uses it for improper purposes, a court of equity can disregard the corporate entity and hold the shareholder personally liable for the corporation’s debts and obligations  Occurs when  There is thin capitalization  No separateness is maintained between the corporation and its shareholders Copyright © 2013 Pearson Education, Inc. Publishing as Prentice Hall

Case 37.1: Piercing the Corporate Veil  Case  Northeast Iowa Ethanol, LLC v. Drizin  Web 2006 U.S. Dist. Lexis 4828 (2006)  United States District Court for the Northern District of Iowa  Issue  Does the doctrine of piercing the corporate veil apply in this case, thus allowing the plaintiffs to pierce the corporate veil of GSI and reach shareholder Drizin for liability for civil fraud? Copyright © 2013 Pearson Education, Inc. Publishing as Prentice Hall

Board of Directors  A panel of decision makers who are elected by the shareholders  Generally compensated for service  Resolutions of the Board of Directors  They specify the decisions that were made by the board during their meetings  Certain actions may require the shareholders’ approval  The board has absolute right of inspection Copyright © 2013 Pearson Education, Inc. Publishing as Prentice Hall

Exhibit 37.2: Board of Directors Copyright © 2013 Pearson Education, Inc. Publishing as Prentice Hall

Selecting Directors  Inside director: A member of the board of directors who is also an officer of the corporation  Outside director: A member of the board of directors who is not an officer of the corporation  Term of office—expires at the annual shareholders’ meeting following a boards member’s election  Staggered terms—Terms lasting two or three years Copyright © 2013 Pearson Education, Inc. Publishing as Prentice Hall

Meetings of the Board of Directors  Regular meetings are held at the times and places established in the bylaws  The board can call special meetings as provided in the bylaws  Quorum of the board of directors: The number of directors necessary to hold a board meeting or transact business of the board Copyright © 2013 Pearson Education, Inc. Publishing as Prentice Hall

Corporate Officers  Employees of a corporation who are appointed by the board of directors  They manage the day-to-day operations of the corporation  Agency authority of officers  Possess authority that may be provided in the bylaws, or as determined by resolution of the board of directors Copyright © 2013 Pearson Education, Inc. Publishing as Prentice Hall

Exhibit 37.3: Corporate Officers Copyright © 2013 Pearson Education, Inc. Publishing as Prentice Hall

Fiduciary Duty  Fiduciary duties: The duties of obedience, care, and loyalty owed by directors and officers to their corporation and its shareholders  Duty of obidience  Duty of care  Duty of loyalty Copyright © 2013 Pearson Education, Inc. Publishing as Prentice Hall

Duty of Obedience  A duty that directors and officers of a corporation have to act within the authority conferred upon them by  State corporation codes  The articles of incorporation  The corporate bylaws  The resolutions adopted by the board of directors  Breach of duty—Personal liability for resultant damages Copyright © 2013 Pearson Education, Inc. Publishing as Prentice Hall

Duty of Care  A duty of corporate directors and officers to use care and diligence when acting on behalf of the corporation  Requires corporate directors and officers to use care and diligence when acting on behalf of the corporation  Breach of duty—Personal liability to the corporation and its shareholders for any damages caused Copyright © 2013 Pearson Education, Inc. Publishing as Prentice Hall

Business Judgment Rule  A rule that says directors and officers are not liable to the corporation or its shareholders for honest mistakes of judgment  Determination of whether duty was met is measured at the time the decision was made  Hindsight not applied  Not liable for honest mistakes of judgment Copyright © 2013 Pearson Education, Inc. Publishing as Prentice Hall

Duty of Loyalty  A duty that directors and officers have not to act adversely to the interests of the corporation  To subordinate their personal interests to those of the corporation and its shareholders  Breach of duty—Corporation can sue the director or officer to recover the secret profit made from a transaction Copyright © 2013 Pearson Education, Inc. Publishing as Prentice Hall

Duty of Loyalty  Usurping a corporate opportunity—If proven the corporation can  Acquire the opportunity from the director/officer  Recover any profits made  Self-dealing  Contracts or transactions with a corporate director or officer is voidable by the corporation if it is unfair to the corporation Copyright © 2013 Pearson Education, Inc. Publishing as Prentice Hall

Duty of Loyalty  Competing with the corporation  Any profits made by nonapproved competition and any other damages caused to the corporation can be recovered  Making a secret profit  The corporation can sue the director or officer to recover the secret profit Copyright © 2013 Pearson Education, Inc. Publishing as Prentice Hall

Case 37.2: Fiduciary Duties of Corporate Directors and Officers  Case  McPadden v. Sidhu  964 A.2d 1262 (2008)  Court of Chancery of Delaware  Issue  Did the plaintiff plead sufficient facts of i2’s board of directors bad faith and Dubreville’s breach of the duty of loyalty to withstand the defendants’ motions to dismiss? Copyright © 2013 Pearson Education, Inc. Publishing as Prentice Hall

Sarbanes-Oxley Act  Enacted by Congress in 2002  Goals  To improve corporate governance  Eliminate conflicts of interest  Instill confidence in public companies Copyright © 2013 Pearson Education, Inc. Publishing as Prentice Hall

Sarbanes-Oxley Act  Foreign Corrupt Practices Act: A federal statute that makes it a crime for U.S. companies, or their officers, directors, agents, or employees, to bribe  A foreign official  A foreign political party official  A candidate for foreign political office, where the bribe is paid to influence the awarding of new business or the retention of a continuing business activity Copyright © 2013 Pearson Education, Inc. Publishing as Prentice Hall

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