Corporations Rules Flashcards Preview

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Flashcards in Corporations Rules Deck (47):
1

 

Piercing The Corporate Veil - TWIST the knife to pierce the corporate veil.

TEN largest shareholders of private company are personally liable for unpaid wages/benefits

WORKER's compensation insurance must be obtained. If not, officers are criminally, strictly liable to injured employee.
 

ILLEGAL conduct by shareholders

SALES or corporate income tax not paid renders directors & officers (D&O) responsible to taxing authority.
 

TORTIOUS conduct of D&O, employees and shareholders cannot use corporate veil to hide from personal liability.

2

 

Contents of Articles of Incorporation. - It's A PAIN to write the articles of incorporation.

 

AUTHORIZED shares
PURPOSE
AGENT authorized to receive service of process INCORPORATORS
NAME and address of corporation

3

 

Contents of Certificate of Incorporation - The corporation's certificate of incorporation lists PVT MCLAW.

 

PREEMPTIVE rights
VALUE of par shares (if to be fixed by shareholders rather than directors)

TRANSFER restrictions on stock
MAJORITY (super-majority, quorum voting requirements)
CUMULATIVE voting rights when electing directors

LESS (whether LESS than majority of shares can vote to voluntarily dissolve corporation) shareholder AGREEMENTS regarding actions authorized without SH meetings, restrictions on D&O powers, or if SH can directly manage company (no BoD)
at-WILL (corporate dissolution at WILL or upon specific event)

4

 

Actions Requiring Shareholder Approval - Shareholders deserve A DAMN SALAD if the corporation makes a big change.

 

AMENDMENT of certificate of incorporation that changes quorum, maxi/super majority, preemptive or cumulative voting rights, and/or corporate purpose

DISSOLUTION (voluntary)
ASSET sale, lease or exchange (>75% of assets) MERGER or consolidation
NAME change
 

SURETY interests in debt not acquired for corporate purposes
AGENT (change of AGENT for service of process) LOCATION (change of LOCATION of corporate office)
ABOLISHING or limiting directors’ liability for negligence
DIRECTOR loans

5

 

Appraisal Rights of Shareholders - If PAM C dissents, she gets appraisal rights.

 

PREEMPTIVE, redemptive or other share of ownership rights affected
ASSET sale, lease or exchange (>75% of corp assets)
MERGER or consolidation into another entity

CUMULATIVE voting rights affected

6

 

Appraisal Right Valuation - The court will AIM for fair value in determining appraisal rights.

ASSET (net ASSET value - where company holds substantial tangible assets (e.g. real estate investment holding co's, retail and wholesale co's))

INVESTMENT value - earning power of corporate stock


MARKET value of stock (court considers arms- length similar sales in same community or marketplace)

7

 

Duties of Directors & Officers - Directors & Officers who get SUED For being OLD can fire a FLARE.

 

SUED - types of conflict of interest

SELF-dealing
USURPATION
EXECUTIVE compensation unreasonable

DIRECT conflict of interest

FOLD - usurpation of corporate opportunity tests

FITNESS & fairness of transaction

OPPORTUNITY was available to corporation

LINE of business was same as corporation's DISCLOSURE was not proper

 

FLARE - defenses to usurping corporate opportunity

FINANCIAL incapacity of corporation to enter K

LEGAL incapacity of corporation to enter K

ABANDONED (purposeful failure to deal)

REJECTED (purposefully declining to transact)

EXPLICIT approval by uninterested BoD or SH

8

 

Actions of Directors that cannot be indemnified - Directors can't be indemnified for RIBALD Gains.

REDEMPTION of shares when not permitted (no surplus)
INTENTIONAL misconduct or knowing violation of law
BAD faith conduct
ASSETS distributed to shareholders before paying creditors
LOAN granted improperly to fellow director without dissent
DIVIDEND improperly declared (no surplus)
GAIN personally derived due to misconduct

9

 

Irrevocable Proxy Voting Rights - You can't revoke a proxy for PEACE.

 

PLEDGED shares (for loan)
ENTITLEMENT to vote is not vested on record date (bought/sold too early/late)
AGREEMENT executed for specified period between shareholders
CREDITOR holding shares as collateral for extending credit
EMPLOYEE owned shares issued with specified proxy requirements

10

 

Elements of 10b-5 - Stock Transfer Liability - In the MIDST of the STORM, it feels like a category 10b- 5.

MATERIAL fact– is the information important? INSTRUMENTALITY of interstate commerce used in connection with transaction (mail)
DAMAGES – civil, regulatory, criminal
Civil: expectation damages or rescission
Regulatory: SEC can impose treble damages (triple profits) and order injunction
Criminal: Federal DOJ can impose criminal fines and imprisonment
STANDING – purchaser/seller who purchased/sold stock in connection with alleged fraud

TIPPER/TIPPEE liability – inside tip given for improper purpose where tipper breached duty and tippee knew of the breach
SCIENTER – defendant had actual knowledge of material misrepresentation regarding material information
TARGETED persons who are already shareholders have standing to sue even if they didn’t buy/sell shares in conjunction with 10b-5 violation

OMISSION or failure to disclose material fact by fiduciary will be treated similarly by the court as material misrepresentation

RELIANCE on misrepresentation resulted in purchase or sale (exception: non-disclosure cases do not require reliance)
MISSTATEMENT of material fact will be treated similarly by the court as material misrepresentation
Corporations - Liability Under Sarbanes-Oxley

11

 

SarbanesOxley - Get the BAD TIC out of your SOx.

BAN on loans to officers/directors of large public companies
ATTORNEY liability attaches if aware of illegal transactions
DISCLOSE ethics requirements, must be made to all persons with authority to transact

TRADING limitations cannot be exceeded or circumvented
INDEPENDENT directors or firms must be appointed to audit records in question CERTIFICATION of internal controls required, with CEO & BoD on the hook for failure to comply.

12

 

Valid Reasons For Judicial or Voluntary Dissolution - To dissolve a corporation, just I.D. the WOLF in the boardroom.

 

ILLEGAL conduct
DIVERSION of corporate assets to directors/officers

WASTE (including that which results from deadlock)
OPPRESSION of minority shareholders

LOOTING
FRAUD

13

 

CORPORATION FORMATION

 

Requires formal creation (filing of paperwork). Governing Law is RMBCAStatutory requirements must be met before it can come into existence.

Step 1: File Articles of Incorporation with the Secretary of State.
Step 2: Incorporators hold an Organization Meeting and create the Bylaws of the Corporation (bylaws govern the internal workings of the corp.; not filed)

14

 

CORPORATION OWNERSHIP & CONTROL

 

Shareholders: Have ownership but no control.  Shareholders elect board of directors.

Board of Directors: Have control and may appoint officers to exercise control-executives.

15

 

CORPORATION: RISK OF LOSS

 

Corporation: Bears the risk of loss.

Shareholders: Bear the risk of loss only to the amount they invested in the corp. and will not exceed the amount that they have invested in the enterprise.

16

 


CORPORATION DOUBLE TAXATION

 

Corporation gets taxed on its profits + Shareholders get taxed on their income.

17

 

PRE-INCORPORATION CONTRACTS: PROMOTERS

 

Persons acting on behalf of a corporation not yet formed.

Liability of Promoters: Anyone who acts on behalf of a corporation and knows the corporation is not yet in existence, will be jointly and severally liable for the obligations incurred.  The promoter’s liability continues after the corporation is formed.

Corporation’s Liability for Promoters’ Actions: The corporation becomes liable when the corporation adopts the promoter’s pre-incorporation contract through:

Express adoption through a board of director’s resolution (board meets and expressly resolves to adopt the contract); or

Implied adoption by knowledge of the contract and acceptance of its benefits.

Promoters’ Fiduciary Duties: Owe to each other and to the corporation the same fiduciary DUTY OF LOYALTY: They may never make a secret profit at expense of the corporation. 

Two Scenarios:

• A sale to the corporation of property acquired by promoter before becoming a promoter; remedy is that the profit is recoverable by the corporation only if sold for more than fair market value.

• A sale to the corporation of property acquired by promoter after becoming a promoter; remedy is that any profit is recoverable by the corporation.

18

 


PRE-INCORPORATION CONTRACTS: SUBSCRIBERS

 

Persons or entities that make written offers to buy stock from a corporation that has not been created.

Revocation: Normally, offers may be revoked until acceptance by the corporation (contract law). However, corporation laws in most jurisdictions allow for a pre-incorporation offer to purchase stock which is irrevocable for six months

19

 

FORMATION REQUIREMENTS

 

ARTICLES OF INCORPORATION: Incorporators sign and file the article of incorporation with the state.

o Name of Corporation: Name must contain some indication of corporate status

o Names and Addresses: Of the agents and incorporators, as well as the corporation’s registered office.

o Authorized Shares: The number of authorized shares must be listed (the maximum number of shares the corporation is authorized to issue).

o Statement of Purpose:  A statement regarding the business purposes of the corporation.  In its absence, it will be presumed that a corporation is formed to conduct any lawful purpose.  

o Non-Corporation Activity: Unless the question restricts the corporation’s purpose, usually conclude that the corporate acts are within the corporation’s powers.

BY-LAWS: Although a corporation does not need to adopt by-laws, the board has the power to adopt and amend the by-laws (unless the Articles give this power to the Shareholders).

FOREIGN CORPORATIONS: A corporation incorporated outside the state that wishes to engage in regular intrastate business must qualify by filing a certificate of authority. Must include ALL information required in the Articles

20

 

DEFECTIVE CORPORATIONS

 

DE FACTO CORPORATION: If the corporation does not meet the above requirements (and thus is not a de jure corporation), it still may be treated as one if the organizers: 

o Have made a good faith, genuine attempt to comply with corporate formalities; and
o Have no knowledge of the lack of corporate status.

CORPORATION BY ESTOPPEL: Persons who have dealt with the entity as if it were a corporation will be estopped from denying the corporation’s existence. The doctrine applies in contract to prevent the corporate entity and parties who have dealt with the entity as if it were a corporation, from backing out of their contracts.

If neither an estoppel nor de facto corporation is found, there is no valid corporation, and the courts will hold only the active business members jointly and severally liable.
 

21

 

PIERCING THE CORPORATE VEIL

 

A shareholder is not liable for the debts of the corporation.

However, always apply the EXCEPTION: The corporation can ‘Pierce the corporate veil’ in order to avoid fraud or unfairness. Thus, there are three situations where a shareholder may be held liable for debts:

o “Alter Ego”: Shareholder fails to observe sufficient corporate formalities (i.e., a shareholder commingles funds/uses corporate assets as their own) and some basic injustice results; or

o Undercapitalization: Shareholder fails to maintain sufficient funds to cover foreseeable liabilities (i.e., the corporation has no insurance, minimal money); or

o Avoidance of Existing Obligations: Where necessary to prevent fraud or to prevent an individual shareholder from using the entity to avoid its existing personal obligations.

 

22

 

PREEMPTIVE RIGHTS OF EXISTING SHAREHOLDERS

 

Allows existing shareholders to maintain the percentage of ownership they have in the corporation by purchasing stock whenever there is a new issuance of stock for cash.  These rights must be expressly granted in the Articles of Incorporation.


 

23

 

DIRECTORS: APPOINTMENT & REMOVAL

 

 

Corporations must have a Board with at least ONE director. However, the bylaws or articles may indicate as many directors as desired, without limitation.  The directors are responsible for the management of the business and affairs of the corporation.

APPOINTMENT: Shareholders elect directors at annual shareholder meetings.  Directors need not be shareholders.

REMOVAL:  Shareholders can remove a director before his or her term expires, with or without cause. However, a director elected by cumulative voting cannot be removed if the votes cast against removal would be sufficient to elect her if cumulatively voted at an election of directors

24

 

VALID MEETING

 

A valid meeting is required for all decisions, unless every director agrees in writing to act without a meeting.  By-laws typically explain how notice will be given. Regular meetings do not require notice, but special meetings require at least two-day notice (and that notice must be in writing).

o Quorum: A majority vote of the board of directors constitutes a quorum. Must have a majority of all directors to take action (unless by-laws state differently).

o Vote: To pass a resolution, only a majority vote of those directors present.

o Agreement: Each director is PRESUMED to have agreed with a Board decision, unless her dissent or abstention is recorded in writing.

Proxies (substitutes) are not allowed. Also, voting agreements are not valid, but conference calls generally are now.
 

25

 


DIRECTOR DUTIES & LIABILITY

 

DUTY TO MANAGE: Directors have a duty to manage the corporation. This does include delegating management functions to committees that recommend actions for the Board to take.

BUSINESS JUDGMENT RULE:  A presumption that directors manage a corporation in good faith and in the best interest of both the corporation and its shareholders.

FIDUCIARIES: Directors are fiduciaries and owe the corporation duties of care and loyalty.

DUTY OF CARE:  A director owes the corporation a duty of care - act with the care that a prudent person would use with regard to her own business (unless the Articles of Incorporation have limited this duty).

DUTY TO DISCLOSE: Directors have a duty to disclose material corporate information to other members of the board.

DOCTRINE OF WASTE: Directors have a duty not to waste corporate assets by overpaying for property or employment services.

DUTY OF LOYALTY: A director owes the corporation a duty of loyalty. A director may not receive an unfair benefit to the detriment of the corporation or its shareholders, unless there has been:

o Material disclosure; and
o Independent ratification.

26

 

ABSOLVING DIRECTOR LIABILITY

 

MATERIAL DISCLOSURE
o The transaction must be approved by a majority of the directors (at least two) without a conflicting interest after all the material facts have been disclosed to the board.

INDEPENDENT RATIFICATION: Directors may defend a claim by obtaining independent ratification through:

o A majority vote of independent directors;
o Majority vote of a committee of at least 2 independent directors; or
o Majority vote of shares held by independent owners of those shares.

27

 

OFFICER DUTIES

 

Determined by the by-laws.

o Duties of Care and Loyalty: Officers owe the same duties of care and loyalty as directors.

o Agents: Officers are agents of the corporation, and their authorized activities can bind the corporation.

o Mandatory Positions: Corporations must have a President, Secretary and Treasurer.

o Power:  Directors have great discretion to select or remove officers, but the corporation will be liable for any breach of contract (if a contract exists).


 

28

 

INDEMNIFICATION OF DIRECTORS & OFFICERS

 

A corporation may indemnify a director for reasonable expenses incurred in unsuccessfully defending a suit brought against the director for reasonable expenses incurred in connection with the proceeding, limited by the following rules:

1. THE CORPORATION MAY NEVER INDEMNIFY A DIRECTOR WHO IS HELD LIABLE TO HIS OR HER OWN CORPORATION: Or if a director received an improper benefit

2. THE CORPORATION MUST ALWAYS INDEMNIFY THE DIRECTOR IF S/HE WINS A LAWSUIT AGAINST ANY PARTY: Such as for Attorney’s fees.

3. SITUATIONS WHERE A CORPORATION MAY PAY THE DIRECTOR:

o Liability to third-parties or settlement with a corporation.
o Director or officer shows that his or her actions were in good faith, and s/he believed his or her conduct to be in the corporation’s best interest.
o Director’s conduct was not unlawful (brought forth in a criminal proceeding).

4. GRANTING PERMISSIVE INDEMNITY: Officers are generally indemnified to the same extent as the director.

o Approval by a majority of independent directors
o Approval by a majority of a committee consisting of at least two independent directors
o Approval by a majority of shares held by independent shareholders 

29

 

RIGHTS OF SHAREHOLDERS:
CONTROL OVER MANAGEMENT

 

POWER TO MANAGE THE CORPORATION: 

o The power to manage a corporation is generally vested in directors.
o Shareholders have no direct control over the management of the corporation. However, they have indirect control, because shareholders have the power to elect the board (of course, check with by-laws and Articles of Incorporation for any unique rules).

SHAREHOLDER INSPECTION RIGHTS: Shareholders may inspect the corporation’s books, papers, accounting records, shareholder records, etc., upon five days written notice stating a proper purpose for the inspection.

 

30

 

RIGHTS OF SHAREHOLDERS:
MEETINGS

 

Shareholders have indirect power through their voting power by which they elect officers, modify by-laws and approve fundamental changes in the corporate structure.

o Annual Meeting: Every corporation must have an annual meeting where at least one director slot is open for election.

o Specially Noticed Meeting: Meeting of the shareholders to vote on a proposal or a fundamental corporate change. Can be called by the Board, president or 10% voting-shareholders.

• Notice must contain the time + place + special purpose for the meeting because nothing else can be addressed in the meeting that is not in the notice or else it is void.

o Location of Meetings: May be held within or outside the state.

o Notice: Shareholders must be notified of meetings not less than 10 or more than 60 days before the meeting. Notice must state the place, day and hour of the meeting, and for special meetings, as stated, the purpose. Notice may be waived in writing or by attendance

31

 

RIGHTS OF SHAREHOLDERS:
SUITS BROUGHT BY SHAREHOLDERS

 

DERIVATIVE SUIT: A direct suit may be brought for a breach of fiduciary duty owed to the shareholder by an officer or director. Any recovery here is for the benefit of the individual shareholder. A shareholder is suing to enforce the corporation’s OWN cause of action.

o The corporation, rather than the shareholder bringing the action, is entitled to recovery.  Nevertheless, the corporation is named as defendant.

REQUIREMENTS FOR A DERIVATIVE SUIT:

o Contemporaneous stock ownership / Standing: Shareholder must own at least one share of stock when the claim arose and throughout the entire litigation.  A shareholder must have been a shareholder at the time of the act complained of or must have become a shareholder through transfer by operation of law from one who was a shareholder at that time (Standing).

o Demand: The Shareholder Demand must be made and:

o Rejected by the Board; OR
o At least 90 days must have passed since the demand was made. 

32

 

RIGHT TO DISTRIBUTIONS

 

Distributions can take the form of dividends, redemptions of shares, and repurchases of shares.

RIGHT TO DISTRIBUTION:  The right to distribution is usually discretionary, with the exception that at least one class of stock must have a right to receive the corporation’s net assets upon dissolution. Declared in Board’s discretion, unless the corporation is insolvent or would be rendered insolvent by the dividend, or the articles limit distribution.

RIGHT TO RECEIVE DISTRIBUTIONS / DIVIDENDS: Declaration of dividends is within the discretion of the board of directors and a strong case is required to induce a court of equity to order the directors to declare a dividend.

PRIORITY OF DISTRIBUTION: Shares may be divided into classes with varying rights.

o Preferred Shares: Have a right to receive dividends BEFORE common shareholders may receive dividends. 

o Participating Shares: Get paid twice – as preferred shares, and then also participate as if common shares.  First, as preferred shares, but also get to participate as if they were also common shares.

o Cumulative Shares: Shares that have the right to be paid not just for current year, but past years that are unpaid

33

 

UNLAWFUL DISTRIBUTIONS

 

LIABILITY FOR UNLAWFUL DISTRIBUTIONS:  Directors are personally liable to a corporation if they vote for a distribution that violates any of the above rules.  That liability extends to the amount of the distribution that is in excess of what could have been properly distributed.

o EXCEPTION- A director is not liable for distributions approved in good faith:

o Based on financial statements prepared in accordance to reasonable accounting practices; or from relying on information from other officers, employees or accountants.

CONTRIBUTION FOR UNLAWFUL DISTRIBUTION: A director who is held liable for an unlawful distribution is entitled to contribution from:

o Every other director who could be held liable for the distribution; and
o Each shareholder for the amount s/he accepted while knowing the distribution was improper

34

 

CLOSELY-HELD CORPORATION

 

In a closely-held corporation, there is only a primary market, meaning the only sales that are going to be made by the corporation are sales from the corporation to potential shareholders. (This is predominant in SMALL businesses taking on a corporate form).

Requirements:

1. Unanimous Shareholder election (choice) evidenced in the Articles, By-laws or a filed agreement.
2. Reasonable Share Transfer Restriction.
3. If the corporation has both:

a. No piercing allowed even if the corporation failed to follow formalities;

b. Possible subchapter S-Corp status, meaning the corporation will be taxed as a partnership

35

 

S-CORP

 

The tax laws permit certain corporations to elect to be taxed like partnerships and yet retain the other advantages of the corporate form.  Such corporations are called S-Corps.

Requirement:

1. Cannot have more than 100 Shareholders who are:

a. Individuals;
b. Living in America; and
c. There is only one class of stock.

 

.

36

 

LIABILITIES OF SHAREHOLDERS

 

Shareholders are not liable for the corporation’s obligations.  In general, Shareholders have no fiduciary duties to the corporation or their fellow shareholders.

EXCEPTIONS:
1. Piercing the corporate veil to render a shareholder liable;
2. Controlling shareholders owe a fiduciary duty to minority shareholders; and
3. Controlling shareholders are liable for selling the corporation to a party who loots the corporation, unless reasonable measures were taken to investigate the buyer’s reputation and plans for the corporation.
 

37

 

FUNDAMENTAL CORPORATE CHANGES: TYPES

 

Require the approval by a majority of all votes entitled to be cast – not just those cast at a meeting.

TYPES OF CHANGES:

o Merger: A merger involves the blending of one or more corporations into another corporation, and the latter corporation survives while the merging corporations cease to exist following the merger.

o Consolidation: A and B become C

o Share Exchange: One corporation purchasing all of the outstanding shares of one or more classes or series of another corporation.

o Sale of a corporation

o Conversion: Involves one business entity changing its form to another business entity (i.e. a corporation changing to an LLC).

o Dissolution: A dissolves

38

 

FUNDAMENTAL CORPORATE CHANGES: STEPS REQUIRED

 

1. Directors must submit a resolution at a valid shareholders meeting;
2. Notice of special meeting; and
3. Approval by a majority of all shares entitled to vote, and by a majority of any voting group adversely affected by the change.
4. EXCEPTION:  This does not apply for short form merges where a parent company merges with a subsidiary (parent corporation must own more than 90% of the stock of the subsidiary).

o Dissenting Shareholder Appraisal Remedy: If a corporation approves a fundamental change, shareholders who dissent may have the right to have the corporation purchase their shares at fair value.

In order to achieve this, a dissenting shareholder must:

1. File a written notice of objection and intent to demand payment before the shareholders vote;
2. Not vote in favor of the proposed change; and
3. Make prompt written demand to be bought out.

39

 


VOLUNTARY DISSOLUTION

 

BY THE DIRECTORS: Directors may dissolve the corporation by filing with the state in which the corporation incorporated articles of dissolution.  This can only be done if shares have not yet been issued or business has not yet commenced. 

o Must occur before dissolution: All corporate debts must be paid, and if shares have been issued, any assets remaining after winding up must be distributed to the shareholders.

BY CORPORATE ACT: The corporation may dissolve by a corporate act approved under the fundamental change procedure.

40

 

INVOLUNTARY DISSOLUTION

 

BY THE SHAREHOLDERS: Shareholders may seek judicial dissolution on any of following grounds:

o Directors are deadlocked in the management of corporate affairs, and the shareholders are unable to break the deadlock;
o Directors have acted or will act in a manner that is illegal, oppressive or fraudulent;
o Shareholders are deadlocked in voting power and failed to elect one or more directors, for a period that includes at least 2 consecutive meeting dates; or
o Corporate Assets are being wasted, misapplied.   

ATTORNEY GENERAL: May seek judicial dissolution on the ground the corporation fraudulently obtained its articles or is abusing its authority

41

 

EFFECT OF DISSOLUTION

 

A corporation that has been dissolved has effectively ended its corporate existence, and is not allowed to carry on any business except that which is appropriate to winding up the affairs.

42

 

FOREIGN CORPORATIONS

 

A foreign corporation may not transact business within a state until it has obtained a certificate of authority from the secretary of state. A foreign corporation may not be denied a certificate of authority merely because the laws of its state of incorporation governing its organization and internal affairs differ from the host jurisdiction. If a foreign corporation is doing business in a state and has not obtained a certificate of authority to do business, it generally cannot bring suit in the foreign state, although it can defend suits. However, failure to obtain a certificate does not usually impair the validity of any contract or corporate act.

 

43

 

ANTI-FRAUD-SECTION 10b-5 OF THE SECURITIES EXCHANGE ACT OF 1934

 

Makes it a crime for any person to use any means or instrumentality of interstate commerce to employ any scheme to defraud, make an untrue statement of material fact, or engage in any practice that operates as a fraud in connection with the purchase of sale of any security.

ELEMENTS FOR A CAUSE OF ACTION:

1. Fraudulent Conduct - Plaintiff must show that the defendant engaged in some fraudulent conduct shown by:

o Scienter: The conduct complained of must have been undertaken with intent to deceive, manipulate or defraud. D must also have recklessness as to truth.

o Materiality: A statement or omission made with a substantial likelihood that a reasonable investor would consider it important in making an investment decision.  A misrepresentation can also be found for failure to disclose a material fact in breach of a fiduciary duty.

2. In Connection with Purchase or Sale of a Security by Plaintiff: This EXCLUDES potential purchasers who do not buy and people who already own shares and refrain from selling.

44

 

INSIDER TRADING

 

Rule 10b-5 prohibits insider trading securities on the basis of inside information not disclosed to the public, that an investor would find useful in decisions to invest.

Liability For:

o Misappropriator: Person who breaches a duty of trust and confidence owed to the source of the information and trades on the market;

o Tipper:  Person who tips inside information for any form of personal benefit (does not have to be sharing in profits) to another who trades on it; or

o Tippee: Person who receives inside information and trades on it knowing the information was disclosed in breach of the tipper’s fiduciary duty AND that the tipper did in fact breach that duty.

Investors in a private action for damages must also prove:

o Reliance:  Must be proven by some financial loss. Show that they relied on the fraud, or that the fraud impacted the market.

o Loss Causation: The fraud provoked the sale or purchase, and caused the financial loss.

o Damages  

45

 

SECTION 16(b) - SHORT SWING TRADING PROFITS

 

Purpose is to prevent unfair use of inside information and internal manipulation of price.

SCENARIOS:

1. A corporation will have purchased and sold, or sold and purchased stock within a six month period; and
2. They owned more than 10% of a corporation stock BEFORE the purchase or sale of the stock!

SITUATIONS WHEN THE RULE APPLIES:

1. Big Corporations: Reporting corporations - (1) listed on a national exchange or (2) at least 500 shareholders and 10 million in assets.
2. Certain Corporation Individuals: Officers, directors, or shareholders w/ more than 10%.
3. Type of Transaction: Where the corporation buys or sells stock WITHIN A SIX MONTH PERIOD (called short-swing trading).

APPLICATION: All profits from such “short-swing” trading are recoverable by the corporation.  If, within 6 months before or after any sale, there was a purchase at a lower price than the sale price, there is a profit.

46

 

SARBANES-OXLEY ACT OF 2002

 

ELEMENTS:
a. Applies to reporting corporations.
b. CEO and CFO must certify that based on the Officer’s knowledge, reports filed with the SEC:

i. Do not contain material misrepresentations or omission; and
ii. Fairly present the financial position of the company.

c. Penalties for willfully certifying a false report can include harsh fines and jail time.

d. A corporation may recover an officer’s profits made within a 12-month period surrounding the false filings if the filings have to be restated.  Additionally, the corporation may recover any incentive-based compensation during that time.

e. Blackout Periods: Corporations can recover any profits made by officers that resulted from trading corporation’s stock during blackout periods of at least three days, when at least half of the employees were prohibited from trading in their retirement plan’s securities. 

47

 

PROFESSIONAL CORPORATION

 

 

Licensed professionals (lawyers, accountants, medical professionals) may incorporate as a Professional Corporation (PC).   However, each professional will be personally liable for his or her own malpractice.  Organizers must file Articles with name designated “Professional Corporation” and shareholders must all be licensed professionals.  The corporation is only allowed to practice one selected profession.