1. LS311 – Business Law I Seminar Presentation UNIT 9 Business Organizations Chapter 26: Corporate Directors, Officer, & Shareholders Chapter 27: Investor Protection, Insider Trading, & Corporate Governance

2. Unit 9 Three (3) items to complete in Unit 9. They are: –Unit 9 Written Assignment (40 points) –Unit 9 DB (20 points) –Unit 9 Case Study (20 points) Let’s discuss Chapter 26 2

3. Chapter 26: Role of Directors & Officers Every corporation is governed by a board of directors. Individual directors are not agents of corporation, only the board itself can act as a “super-agent” and bind the corporation. A director can also be a shareholder, especially in closely-held corporations.

4. 4 Election and Compensation of Directors The number of directors is set forth in the articles of incorporation: –Directors are appointed at the first organizational meeting –In closely held companies, directors are generally the incorporators and/or the shareholders –Term of office is generally for one year –Director can be removed for cause In very large companies, directors can be compensated, and may be officers as well.

5. 5 Board of Directors’ Meetings Directors hold meetings pursuant to bylaws with recorded minutes Special meetings may be called with sufficient notice Meetings require QUORUM (minimum number of directors to conduct official corporate business, usually majority) Each director generally has one vote

6. 6 Rights of Directors Directors have the right to: Participate in corporate decisions and inspect corporate books and records Compensation (usually a nominal sum) and indemnification. If a director is sued for acts as director, the corporation should guarantee reimbursement (indemnification) or purchase liability insurance to protect the board from personal liability

7. 7 Officers serve at the pleasure of the Board of Directors but have fiduciary duties to company as well Their employment relationships are generally governed by contract law and employment law Officers may be terminated for cause Corporate Officers and Executives

8. 8 Fiduciaries of corporation - ethical & legal duties Duty of Care –Act in good faith and in best interests of the corp.; –Make informed and reasonable decisions; and –Exercise reasonable supervision Duty of Loyalty –No conflict of interest –No insider trading A dissenting director is rarely held liable Duties and Liabilities of Directors and Officers

9. 9 Business Judgment Rule Immunizes a director or officer from liability from consequences of a business decision that turned sour Court will not require directors or officers to manage “in hindsight” As long as decision was reasonable, informed, made in good faith and in the best interests of the corporation, BJR will apply

10. 10 Role of Shareholders Ownership of shares grants a shareholder an equitable ownership interest in a corporation. Shareholders generally have no right to manage the daily affairs of the corporation, but do so indirectly by electing directors. Shareholders are generally protected from personally liability by the corporate veil of limited liability.

11. 11 Common shareholder - one vote per share Articles and bylaws can exclude or limit voting rights of certain classes of stock Quorum must be present Cumulative Voting allows minority shareholders to get a board member elected Shareholder Voting

12. 12 To vote To have a stock certificate To purchase newly issued stock To dividends, when declared by board To inspect corporate records To transfer shares, with some exceptions To a proportionate share of corporate assets on dissolution To file suit on behalf of corporation Rights of Shareholders

13. 13 Shareholders can sue a 3 rd party on behalf of the corporation if the Directors fail or refuse to correct the wrong or injury. Directors may refuse to take action because they might personally be liable. Any damages recovered go to corporation’s treasury. Shareholder’s Derivative Suit

14. 14 Shareholders are generally not liable for the contracts or torts of the corporation. If the corporation fails, shareholders cannot lose more than their investment, except when: –A shareholder hasn’t paid for stock pursuant to the stock subscription agreement. –Shareholder buys “watered stock” which is below the stock’s par value. Liabilities of Shareholders

15. Chapter 27: The Securities Acts In response to the stock market crash of 1929 and the Great Depression, Congress enacted two acts: –Securities Act of 1933 –Securities Exchange Act of 1934 Apply to public companies To structure and oversee the offering, selling, and trading of securities in ways that would protect investors 15

16. Securities Act of 1933 Requires that investors receive information about securities offered for public sale Prohibits fraud in the sale of securities by requiring that securities be registered Registration includes information including –a description of properties and business, –a description of the security to be offered for sale, –information about management of the company, & –financial statements certified by independent accountants 16

17. 17 Registration Process Registration statement does not become effective until approval by SEC. Pre-Filing Period: issuer cannot offer or sell securities. Waiting Period: securities can be offered by not sold. 2005: Free-writing prospectus. Post-Effective Period: registration effective 20 days after approval.

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19. 19 Violations of the 1933 Act Intentional or negligent fraud of investors by misrepresenting or omitting material facts in the registration statement and/prospectus. Defenses: Statement left out was not material; Plaintiff knew about fraud and purchased stock; Registrant believed statements were true. Penalties : –Criminal: up to 5 years in prison and $10,000 fine. –Civil: damages, refund of investment, injunction.

20. Securities Exchange Act of 1934 Created the Securities and Exchange Commission (SEC) Power to register, regulate, and oversee brokerage firms, transfer agents, clearing agencies, and securities self-regulatory organizations To give the investor confidence and prevent another collapse in the system 20

21. 21 Section 10(b) and Rule 10b(5) Section 10(b) prohibits the use of any manipulative or deceptive device or contrivance in contravention of rules and regulations of SEC. Rule 10b(5) prohibits the commission of fraud in the connection with the purchase or sale of any security.

22. 22 Advance information available to corporate officers and directors that can affect future value of stock. Insider information must be material Must be a fiduciary relationship for liability Insider Trading

23. 23 Insider Reporting and Trading—Section 16(b) Section 16(b) –Recapture by corporation of profits during previous six months gained by insider trading. –Applies to stocks, warrants, options and convertible securities. Proxy Statements, Section 14(a) –Whoever solicits a proxy must fully disclose all of the facts and which shareholders must vote.

24. 24 Comparison of 10b-5 and 16(b)

25. Sarbanes-Oxley Act of 2002 In response to the Enron fall in 2001, Congress enacted the Sarbanes-Oxley Act of 2002 (SOX). –To protect investors by improving the accuracy and reliability of corporate disclosures, –To enhance corporate responsibility, –To end corporate and accounting fraud, and –To restore the image of stock purchases as investments worth the risk. Requires documented internal controls Requires CEO and CFO certifications 25

26. 26 Key Provisions: Sarb-Ox

27. Unit 9 Written Assignment Chapter 27 Case Scenario: Dale Emerson served as the chief financial officer for Reliant Electric Company, a distributor of electricity serving portions of Montana and North Dakota. Reliant was in the final stages of planning a takeover of Dakota Gasworks, Inc. a natural gas distributor that operated solely within North Dakota. Emerson went on a weekend fishing trip with his uncle, Ernest Wallace. Emerson mentioned to Wallace that he had been putting in a lot of extra hours at the office planning a takeover of Dakota Gasworks. On returning from the fishing trip, Wallace met with a broker from Chambers Investments and purchased $20,000 of Reliant stock. Three weeks later, Reliant made a tender offer to Dakota Gasworks stockholders and purchased 57% of Dakota Gasworks stock. Over the next two weeks, the price of Reliant stock rose 72% before leveling out. Wallace then sold his Reliant stock for a gross profit of $14,400. 27

28. Unit 9 Written Assignment Chapter 27 For your Assignment answer the following questions: 1.Would registration with the SEC be required for Dakota Gasworks securities? 2.Did Emerson violate Section 10(b) of the Securities Exchange Act of 1934 and SEC Rule 10b-5? 3.What theory or theories might a court use to hold Wallace liable for insider trading? 4.Under the Sarbanes-Oxley Act of 2002, who would be required to certify the accuracy of financial statements filed with the SEC? Note: Your assignment must be in APA format, include a title page, the paper itself (the discussion) and a reference page 28

29. Questions & Reminders Questions on Unit 9 material? Remember to complete all Assignments – Unit Self-Check Quiz (Not for a grade) – Discussion (See Discussion Board Posting Requirements) – Written Assignment – Case Analysis Office Hours: Thursdays 7-9PM (ET) Have a great week! Good luck on the final! 29