1. © 2010 Pearson Education, Inc., publishing as Prentice-Hall 1 COPORATE GOVERNANCE AND THE SARBANES-OXLEY ACT © 2010 Pearson Education, Inc., publishing as Prentice-Hall CHAPTER 37

2. © 2010 Pearson Education, Inc., publishing as Prentice-Hall 2 Shareholders Own the corporation. Not agents of the corporation. –Cannot bind the corporation to contracts. Have right to vote on certain matters. –E.g., election of directors and fundamental changes in the corporation.

3. © 2010 Pearson Education, Inc., publishing as Prentice-Hall 3 Shareholder Meetings –Annual meetings must be held at time set by bylaws. Elect directors, choose auditor, take other actions. –Special shareholders’ meetings may be called by board, holders of at least 10 percent of stock, or others authorized. Emergency or important issues.

4. © 2010 Pearson Education, Inc., publishing as Prentice-Hall 4 Shareholder Meetings (continued) Shareholders must receive advance, written notice of all meetings. –Electronic notice generally allowed. Shareholders may vote by proxy. –Appoint agent to vote. –Agent’s identity indicated on proxy card. –Proxy generally valid for 11 months.

5. © 2010 Pearson Education, Inc., publishing as Prentice-Hall 5 Voting Requirements At least one class of shares of the corporation must have voting rights. Shareholders of record as of set date allowed to vote. –Record date not more than 70 days before the shareholders’ meeting. Corporation must prepare and maintain shareholders’ list. –Must be available for inspection.

6. © 2010 Pearson Education, Inc., publishing as Prentice-Hall 6 Quorum Required number of shares that must be represented in person or by proxy to hold a shareholders’ meeting. Once quorum is present, withdrawal of shares has no effect. The affirmative vote of the majority of the voting shares represented at a shareholders’ meeting constitutes an act of the shareholders for actions other than for the election of directors.

7. © 2010 Pearson Education, Inc., publishing as Prentice-Hall 7 Voting for Election of Directors Straight (Noncumulative) Voting – Each shareholder votes the number of shares he or she owns for each of the positions open. –Majority shareholder therefore can choose the board. Cumulative Voting – Shareholder can accumulate all of his or her votes and vote them all for one or a few candidates. –Gives minority shareholders a better opportunity to elect someone to board.

8. © 2010 Pearson Education, Inc., publishing as Prentice-Hall 8 Supramajority Voting Requirement Articles of incorporation or bylaws may require more than a majority of shares to constitute a quorum or for votes for mergers, consolidation, or other important matter.

9. © 2010 Pearson Education, Inc., publishing as Prentice-Hall 9 Voting Agreements Shareholders agree in advance as to how their shares will be voted. –Voting Trusts. Legal title to shares held in name of trustee, who votes the shares. –Shareholder Voting Agreements.

10. © 2010 Pearson Education, Inc., publishing as Prentice-Hall 10 Selling of Shares Shareholders may enter agreements to prevent unwanted persons from becoming owners. –Right of first refusal –Buy-and-sell agreement Articles of incorporation may grant preemptive rights to existing shareholders to buy new shares, thereby avoiding dilution of interests.

11. © 2010 Pearson Education, Inc., publishing as Prentice-Hall 11 Right to Receive Information Corporation must furnish shareholders with annual financial statement. Shareholders have absolute right to inspect shareholders’ list, articles, bylaws, minutes of shareholders’ meetings for past 3 years. Must demonstrate proper purpose to inspect accounting and tax records, minutes from board and committee meetings, shareholders’ meetings beyond 3 years.

12. © 2010 Pearson Education, Inc., publishing as Prentice-Hall 12 Dividends Distribution of profits of the corporation to shareholders. Paid at discretion of board. Shareholders on record date receive dividends. May use additional shares of stock as a dividend. –Not a distribution of corporate assets. –Does not increase shareholder’s proportionate ownership.

13. © 2010 Pearson Education, Inc., publishing as Prentice-Hall 13 Shareholder Derivative Lawsuits Brought on behalf of corporation against a third party, when corporation failed to sue. Brought by shareholder who held shares at time of injury, who fairly represents interests of corporation. –Shareholder must first make written demand on corporation to bring a lawsuit. Court may dismiss if lawsuit not in best interests of corporation. Any award goes to corporate treasury; corporation pays shareholder’s expenses.

14. © 2010 Pearson Education, Inc., publishing as Prentice-Hall 14 Piercing the Corporate Veil If a shareholder dominates corporation and uses it for improper purposes, court can disregard corporate entity, and hold the shareholder personally liable for the corporation’s debts and obligations. –E.g., thin capitalization; commingling of personal and corporate assets. –Alter ego doctrine.

15. © 2010 Pearson Education, Inc., publishing as Prentice-Hall 15 Board of Directors Elected by the shareholders. Generally compensated for service. Responsible for formulating policy decisions affecting the corporation. The board may initiate certain actions that require shareholders’ approval by passing resolution. Have an absolute right of inspection.

16. © 2010 Pearson Education, Inc., publishing as Prentice-Hall 16 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. –Often selected for business expertise.

17. © 2010 Pearson Education, Inc., publishing as Prentice-Hall 17 Term of Office The term of a director’s office expires at the next annual shareholders’ meeting following his or her election, unless otherwise specified in articles of incorporation. Directors instead may be elected to staggered terms of 2 or 3 years.

18. © 2010 Pearson Education, Inc., publishing as Prentice-Hall 18 Meetings of the Board of Directors The directors can only act as a board. They cannot act individually on the corporation’s behalf. Every director has the right to participate in any meeting of the board of directors. Each director has one vote. Directors cannot vote by proxy. Regular and special meetings are established by bylaws.

19. © 2010 Pearson Education, Inc., publishing as Prentice-Hall 19 Quorum and Voting Requirement Simple majority usually constitutes quorum. Articles and bylaws may increase this number. If quorum is present, simple majority of quorum approves or disapproves actions.

20. © 2010 Pearson Education, Inc., publishing as Prentice-Hall 20 Committees of the Board of Directors Boards can create committees to handle specific duties. Audit committee of public company has responsibilities imposed by Sarbanes-Oxley Act. –Only outside directors on audit committee. –At least one financial expert. –Audit committee oversees CPAs employed to audit company. –Audit committee yearly assesses internal controls.

21. © 2010 Pearson Education, Inc., publishing as Prentice-Hall 21 Corporate Officers Board of directors appoint officers. Directors delegate management authority to officers. Most corporations have president, vice president, secretary, and treasurer. Officer can be removed by board.

22. © 2010 Pearson Education, Inc., publishing as Prentice-Hall 22 Agency Authority of Officers Officers and agents of the corporation have such authority as may be provided in the bylaws or as determined by resolution of the board of directors. Corporation may ratify unauthorized act. –Officers liable for unauthorized actions.

23. © 2010 Pearson Education, Inc., publishing as Prentice-Hall 23 Fiduciary Responsibilities of Directors and Officers Duty of Obedience Duty of Care Duty of Loyalty

24. © 2010 Pearson Education, Inc., publishing as Prentice-Hall 24 Duty of Obedience Duty to act within the authority conferred by statute, articles of incorporation, bylaws, and resolutions adopted by the board of directors. Directors and officers who either intentionally or negligently act outside their authority are personally liable for any resultant damages to the corporation or its shareholders.

25. © 2010 Pearson Education, Inc., publishing as Prentice-Hall 25 Duty of Care Duty to use care and diligence when acting on behalf of the corporation. A director or officer who breaches this duty of care is personally liable to the corporation and its shareholders for any damages caused by this breach.

26. © 2010 Pearson Education, Inc., publishing as Prentice-Hall 26 Duty of Care (continued) Duty is discharged if officer or director acts: 1. In good faith. 2. With the care that an ordinary prudent person in a like position would use under similar circumstances. 3. In a manner he or she reasonably believes to be in the best interests of the corporation.

27. © 2010 Pearson Education, Inc., publishing as Prentice-Hall 27 Duty of Care (continued) Violations of this duty of care include acts of negligence and mismanagement, including failure to: –Make a reasonable investigation of a corporate matter. –Attend board meetings on a regular basis. –Properly supervise a subordinate who causes a loss to the corporation. –Keep adequately informed about corporate matters. –Take other actions necessary to discharge duties.

28. © 2010 Pearson Education, Inc., publishing as Prentice-Hall 28 Business Judgment Rule Determination of whether duty was met measured at time decision made. –Hindsight not applied. Not liable for honest mistakes of judgment.

29. © 2010 Pearson Education, Inc., publishing as Prentice-Hall 29 Duty of Loyalty Duty not to act adversely to the interests of the corporation, and to subordinate their personal interests to those of the corporation and its shareholders. Breach of the duty of loyalty usually occurs because of intentional conduct.

30. © 2010 Pearson Education, Inc., publishing as Prentice-Hall 30 Duty of Loyalty (continued) Breaches of the duty of loyalty include unauthorized: –Self-dealing –Usurping a corporate opportunity –Competing with the corporation –Making a secret profit that belongs to the corporation

31. © 2010 Pearson Education, Inc., publishing as Prentice-Hall 31 Sarbanes-Oxley Act Passed in response to corporate scandals of late 1990s, early 2000s. Goals to improve corporate governance, eliminate conflicts of interest, instill confidence in public companies.

32. © 2010 Pearson Education, Inc., publishing as Prentice-Hall 32 Sarbanes-Oxley (continued) CEO and CFO certification of financial reports. Reimbursement of bonuses and incentive pay if company must restate financial statements due to noncompliance. Prohibition on personal loans to directors or officers. Tampering with evidence of fraud a crime. Those who have committed securities fraud may not serve as officer or director.