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UPA 18(a)- partners share profits equally after capital contributions and liabilities
are repaid
-contrary to Kovacik (case treats non-contributing partner better than UPA,
doesn't share moneyman's loss)
40(b)- absent contrary agreement, order of liabilities repaid upon dissolution is:
(1) non-partner creditors
(2) partner liabilities (not capital or profits)
(3) partner capital
(4) partner profits
Default Rules
-Majoritarian default (what most people would agree on ex ante)- rule that most
contracting parties would want most of the time, so most likely that these specific
parties also would have
-saves transaction costs and doesn't have to think as hard
-many parties would care about equity, some wouldn't
-Penalty default- not necessarily what parties would have bargained, can have
inequitable effect
-policy concern to deter certain behaviors the court doesn't like
-sometimes one party has information the other party doesn't
-Address some cognitive bias (e.g. over-optimism, "sticky" defaults, don't contract
around even though you should)- arguing over losses when you only predict profits
can be deemed unnecessarily fractious
-Protect some party- e.g. non-repeat player
-Possible rules:
(1) All capital losses borne by capital partner alone (Kovacik)
-advantage b/c capital partner more able to bear the loss
-disadvantage b/c service partner may walk away untouched while
other party loses
-incentive problem: service partner may not care as much if not liable
for loss, often they are the person that came up w/ the idea and
more control over whether it fails
(2) Sharing of capital losses in accordance w/ sharing of profits (statute)
-
(3)
Buyout agreements
I. Trigger events
A. Death
B. Disability
C. Will of any partner
II. Obligation to buy vs. Option
A. Firm
B. Other investors
C. Consequences of refusal
i. If there is obligation
ii. if there is no obligation
III. Price
A. Book value
B. Appraisal
C. Formula (e.g. 5x earnings)
D. Set price each year
E. Relation to duration (e.g. lower price in first five years)
IV. Method of payment
A. Cash
B. Installments (w/ interest?)
V. Protection against debts of partnership
VI. Procedure for offering either to buy or sell
A. First mover sets price to buy or sell
B. First mover forces others to set price
-Partners have right to dissolve and right to refuse new partners; LLC's don't, so
more important to plan
-partnerships are owned by the managers, while corporations aren't
3 Types of Agreements:
-Restrictions on transfer
-can't sell shares w/o the permission of the corporation or the other
shareholders
-try to have stable direction and management, don't risk too much
involuntary change
-protect non-selling shareholders
-very important in corp., where no restriction on selling
-Grant entity or other investor the right, but not obligation, to purchase if a
triggering event
-protect non-selling shareholders, prevents outsiders from joining and retains
status quo
-doesn't provide liquidity to seller
-Provisions requiring the entity to purchase the interest upon a triggering event
-Protect selling shareholder by providing liquidity
-Important in both corp. and partnership context
Revised Uniform Limited Partnership Act: §303(a)- limited partner not liable for
limited partnership unless
(1) also a general partner or
(2) exercises limited partner rights and powers and also takes part in control
of the business
-but liable only to persons transacting business w/ the limited
partnership and who "reasonably believe, based upon the
limited partner's conduct that the limited partner is a general
partner"
-merely consulting w/ and advising general partners w/ respect to
limited partnership's business is not taking part in its control
"Promoter": term of art for a person identifying a business opportunity and puts
together a deal by forming a corporation as the vehicle for investment by others
Third-Party Sales- No fiduciary duties nor duty to disclose initial purchase price, but
can't misrepresent
-Even if fraudulent misrepresentations, question as to extent of damages (i.e.
would you still have paid the same amount anyway?)
Principal/Agent Sales- RS 2d Agency 388: agent profiting while transacting on
behalf of principal must disgorge profits to principal, unless otherwise agreed
-promotes fair dealing and openness
-not based on actual damages
Promoter/Corporation Sales- Individual shareholders can't sue personally, must sue
on behalf of corp.
-promoter owes fiduciary duty to corp., so can be compelled to disgorge
undisclosed profits
-i.e. Art forms corp. and sells all its shares to Paula, then sells land to the
corp.
-but if Art sells Paula and Paula is the one who forms the corp. more like
arms-length transaction unless Art acts as Paula's (not the corp.'s) agent
-if promoter has retained interest in corp. and profits from sale (sells land to
his own corp.) courts split whether fiduciary duty owed to person he sells
shares to after few days (Old Dominion)
-problematic if held for more than a few days, complicates due
diligence
-when does promoter's fiduciary duty to corp. end? at sale? depends
on
Enterprise liability: when multiple corporations really all ran as one corporation
-might be useless if all corporations equally broke
-easier to get than veil-piercing (so just buy more insurance)
-easier to keep minutes and keep fingers out of corp. coffers than to
buy separate office space, buy extra phone lines, etc.
Respondeat superior: agency should be different than veil-piercing (but Walkovszky
mixes them)
-based on control
Piercing corporate veil: when corporations used for personal ends
-might be useless if individual has all money tied up in other corporations
(then look to enterprise liability)
-in many jurisdictions, lack of formalities by itself insufficient
Difference b/t respondeat superior and veil-piercing: passive investors protected
under respondeat superior b/c don't assert control, but in veil-piercing doesn't
necessarily require passive investors to have control (their money can still be
commingled, formalities can be absent, and corporation can operate for the passive
investor's personal ends w/o the investor controlling or even realizing this)
-If derivative action against D's settled, corp. can pay their legal fees
-If D's lose at trial, besides insurance they pay damages and may have to pay legal
fees as well
-Incentive for managers to have corp. settle
-P's attorneys usually the drivers
-Court sometimes awards individual recovery (Lynch v. Patterson: wronged SH
owned all of the corp. that the wrongdoers didn't own)
Roberta Romano- financial recoveries in only half of settled suits, and per share
recoveries small
Thompson & Thomas- many are not strike suits, ones not providing relief to the
corp. are usually dismissed quickly
-Directors and officers often have conflicted interest w/ SH's when they have options
b/c their compensation will favor capital appreciations over dividends
-prefers repurchase to dividends (distributes money to SH's while not
lowering stock price)
-Normally directors and officers have fiduciary duties to corp. and not SH's, b/c D's
and O's have active management role in the company while SH's are usually only
passive investors
-but sometimes wholly owned, majority-controlled, or even minority-
controlled SH's can assert great influence over the operation of the corp.
-in that case fiduciary duty is owed to the corp. and all of its SH's therein,
including other SH's
Sinclair Oil Corp. v. Levien (Del. 1971)
Facts: Sinclair organizes Sinven for Venezuelan oil operations, owning 97%,
nominates all board members, and due to this domination Sinclair owed Sinven a
fiduciary duty, Chanchellor holds this means its relationship must meet test of
intrinsic fairness
-minority SH owning other 3% alleges Sinclair depletes Sinven by paying
excessive dividends during period when Sinclair needed cash (108M dividends
and 70M earnings from 1960-66)
-alleges corporate opportunity claim that Sinclair deprived Sinven of
expansion opportunities, giving them to other subsidiaries instead
-alleges breach of contract w/ Sinclair wholly owned subsidiary by paying
Sinven late and not purchasing minimum amount of crude
Rule:
-Intrinsic fairness test involves (1) high degree of fairness and (2) burden on Sinclair
to prove it
-applied in parent/subsidiary situations where
-parent controls transactions and terms- on both sides of the
transaction, and
-self-dealing occurs: parent benefits to the exclusion and detriment of
subsidiary's minority SH's
-dividend declarations can be subjected to the intrinsic fairness test, though
not required in all cases of a dominated board
-Business judgment rule: directors' judgment presumed sound if attributable to "any
rational business purpose"
-Corporate opportunity doctrine
Analysis:
-Chancellor erred in applying intrinsic fairness and not business judgment rule for
dividends:
-not self-dealing b/c dividends paid to all SH's
-motives immaterial unless both (1) shown to be improper and (2) amounted
to waste
-Oil opportunities around world taken by Sinclair and not Sinven not improper b/c
never came to Sinven
-how Sinclair allocates its expansion among subsidiaries is subject to
business judgment rule
-Breach of contract was self-dealing b/c Sinclair benefitted from breach at minority
Sinven SH's loss
-therefore intrinsic fairness test correct for contract claim: Sinclair must prove
that causing Sinven not to enforce contract was intrinsically fair, which they fail to
do
-Pepper v. Litton: directors and dominant stockholders are fiduciaries, their powers
are in trust, and their dealings w/ the corp. subjected to rigorous scrutiny
-for challenged transactions they must show
(1) transacted in good faith, and
(2) inherently fair from viewpoint of corp. and those interested therein
-When SH owns large percentage of corp.'s stock, that corp. is inevitably dominated
by that SH, and however hard SH tries to insulate corp. from himself, and since
managers realize that P can fire or promote them, difficult to protect against
minority SH fiduciary duty suits (M&A possibility?)
-"Par value" is minimum amount corp. had to receive when it sold stock (set in
charter)
-Stock sold by issuer for less than par value was called "watered stock"
-notion of par value as a trust fund for creditors
-SH who bought watered stock was liable to creditors of the firm for amount
underwater
-Par value came to be an arbitrary figure having no relation to price or intrinsic
value
-low par or no par stocks were issued having $1 or less par value
-in Delaware can have no par value but still must set some amount of legal
par
-DGCL 154: "capital" is aggregate par value for SH's equity, and "surplus" is
additional value
-surplus can be distributed to SH's, but capital cannot (held in trust for
creditors' benefit)
-170: board can pay dividends if paid out of surplus
-if no surplus, dividends can be paid out of its net profits for the fiscal
year in which the dividend is paid or the preceding fiscal year
("nimble dividends")
Delaware statutes:
Cumulative dividends: 170 and 151(c)
Convertible stock: 151(a) and 151(e)
Callable stock: 151(c)
Zahn v. Transamerica Corporation (3d Cir. 1947)
Facts: minority SH of Axton-Fisher Tobacco Company, sues majority SH
Transamerica for forcing redemption of stock for 80.80 per share w/o allowing SH
participation in asset liquidation (in which case they would have gotten $240)
-preferred stocks have par value 100, dividend of 6, and liquidation value of
106; Class A stock has 3.20 dividend and Class B has 1.60, A and B share
remaining dividends; upon liquidation Class A receives two times as much as Class
B
-Class A convertible into Class B stock, all Class A stocks callable upon 60
days' notice, for $60
-Class B vested w/ voting rights, but Class A had equal rights b/c 4 straight
quarterly dividends unpaid
-Transamerica builds up about 80% of Class B and 67% of Class A stock,
therefore controlling the majority of the board and its affairs
-Axton-Fisher's biggest asset was leaf tobacco worth 6.3M, Transamerica
knew that market conditions actually made it worth 20M
-complaint alleges that Transamerica sells Class A stock, has the Class A
stocks called for 80.80 (60 call price plus 20.20 accrued dividends), then
liquidates tobacco stock, pocketing proceeds as Class B SH's
[Class A more protected from downside risk, but captured none of the upside
potential, when economy is bad or company is growing and needed quick cash
Class A's preferences facilitated raising of capital; Class B shares for less risk-
adverse investors
-potential conflict of fiduciary duty b/t Class A and Class B: can't maximize
both tranches at the same time, one side will be against a call, depending on
the price]
Rule: SCOTUS Southern Pacific Co. v. Bogert: "majority has the right to control; but
when it does so, it occupies a fiduciary relation toward the minority, as much so as
the corporation itself or its officers and directors"
-directors can't declare or withhold dividends, or any other corp. action, for
personal profit
Analysis: right to call stock reserved to directors, not SH's
-when voting as a SH, can consider one's own personal benefit
-when voting as a director, trustee representing all SH's interests, so can't
use director vote for own personal benefit at SH's expense
-Transamerica was basically Axton-Fisher's puppeteer
-no reason to liquidate assets after Class A redemption
-if there had been full disclosure, SH's would have converted instead of
calling
[court turns this into a disclosure case- damages are what A's would have had done
given full disclosure]
[general rule that fiduciary duty runs greatest to the most junior stock]
Fliegler v. Lawrence (Del. 1976)
Facts: John Lawrence, president of gold and silver corporation Agau, individually
acquires antimony properties under 60k lease
-offered to transfer to Agau but board declines, so instead transfers to USAC,
corp. formed just for this purpose and majority owned by defendants, also giving
Agau option to purchase
-Agau later exercises option, purchasing property from USAC for 800,000
shares of Agau stock
Rule: Gottlieb v. Heyden Chemical Corp.: SH ratification (even if less than
unanimous) of an "interested transaction" shifts the burden to the objecting SH to
show terms so unequal amounts to waste of corp. assets
-144(a): three ways to give safe harbor for interested transactions, including (2)
material facts disclosed to voting SH's, and SH's in good faith approve the
transaction (also safe harbor if disinterested board approves or transaction is fair)
Analysis: Gottlieb rule doesn't shift burden of proof here b/c the majority of votes for
ratification were made by interested SH's, and only about one-third of disinterested
SH's voted
-therefore departure from objective fairness test isn't warranted
[court basically inserts "disinterested" into the statute 144(a)(2)]
-Defendants say 144(a)(2) doesn't require ratifying SH's to be disinterested or
independent
-but this isn't meant to sanction unfairness or removing transaction from
judicial scrutiny
-statute not to provide "broad immunity" but "merely removes an 'interested
director' cloud"
-But transaction still intrinsically fair, the opportunity was lucrative and the price
was well-justified
-144 not meant to fill in deficiencies of disclosure (that goes against basic agency
principles), but meant to protect directors from corporations opportunistically or
arbitrarily voiding K's w/ the director
Good Faith
-Good faith required for directors in numerous situations:
-to be entitled to legal expense indemnification (DGCL 145)
-full protection for reliance on corporate books or officer reports (DGCL
141(e))
-partial insulation for related party transactions (DGCL 144(a)(1)-(2))
-BJR presumes directors act in good faith (e.g. Aronson v. Lewis)
-Cede & Co. v. Technicolor, Inc. (Del. 1993): P has burden of producing evidence
rebutting presumption that directors acted with good faith, loyalty, and due care
-if P fails to meet this evidentiary burden, BJR attaches to protect decisions of
D's and O's
-if P meets this burden, burden shifts to directors to prove "entire fairness" of
the transaction
-that case created proposition that good faith was freestanding fiduciary duty
In re The Walt Disney Co. Derivative Litigation (Del. 2006)
Facts: When Disney's president dies and CEO Eisner undergoes quadruple bypass,
Disney looks to find replacement in Michael Ovitz, friend of Eisner for 25 years and
powerful partner in prestigious Hollywood agency
-when negotiating employment, Ovitz thinks he will run Disney together w/
Eisner, but Eisner thinks otherwise
-received 20-25M per year from CAA, and refused to give it up unless given
downside protection
-draft of Ovitz's employment agreement (OEA) provided for five-year contract
modeled on previous contracts, with two tranches of options:
-one million options each at end of years 3, 4, and 5, w/ guaranteed
value at least 50M
-two million options upon renewal
-proposed OEA meant to protect both parties from premature termination:
-if Ovitz walked away, he gave up remaining compensation and could
be enjoined from working for competitors
-if Disney terminated w/o fault of Ovitz, he would receive no-fault
payment, consisting of his remaining salary, 7.5M a year for
unaccrued bonuses, immediate vesting of first tranche of options
and 10M cash out for second trance
-though Ovitz's salary would be very high for corporate officers and
draw criticism, still lower than he could receive from a private
company, meriting downside protection and upside opportunity
-executive compensation consultant determined that OEA would provide
Ovitz w/ approximately 24.1M per year
-Eisner tells Ovitz that options reduced from single grant of 5M options to the
two tranches, and that Ovitz would join only as president, not co-CEO; Ovitz
accepts and later signs a letter agreement (OLA)
-compensation committee approves employment agreement, subject to
further negotiation within the contract's terms and conditions; board then
unanimously names Ovitz president
-within few months Ovitz doesn't fit well w/ other executives, Chancellor
rejects claims of malfeasance, lying, and excessive expenses and gift-giving
-Eisner favors a "trade" w/ Sony since Ovitz had connections there and Disney
wouldn't have to pay the severance package, but those negotiations fell through
-legal counsel for Disney advises them that no cause existed, instead of
sending Ovitz letter that he wasn't welcome at Disney, Eisner tells Ovitz two
days later; Ovitz gets 130M severance after serving only 14 months
-SH's file suit against the directors and Ovitz
-allege directors violated due care and good faith by approving OEA,
including NFT, and approving severance payment to Ovitz
-allege Ovitz violated due care and loyalty by negotiating and
accepting NFT provision
Rule:
-De facto officer is one who actually assumes the office via election or
appointment and discharges his duties, but for some reason hasn't yet assumed
the de jure title
-DGCL empowers board to delegate power to a committee for decisions
including compensation
-Bad faith involves three categories:
(1) subjective bad faith- fiduciary conduct motivated by actual intent to harm
(2) lack of due care- fiduciary action taken solely by reason of gross
negligence and w/o any malevolent intent
-gross negligence (including failure to inform oneself of material facts),
without more, cannot constitute bad faith
(3) in between first two ("intentional dereliction of duty, a conscious disregard
for one's responsibilities")
-difference b/t good faith and due care important b/c violations of good
faith are non- exculpable and non-indemnifiable, 102(b)(7)(ii)
-some in between standard needed for violations not involving duty of
loyalty but that is worse than gross negligence ("simple inattention or
failure to be informed")
-i.e. fiduciary intentionally acts w/ purpose other than corp.'s best
interests, intends to violate applicable positive law, intentionally
fails to discharge known duty to act
-but attempting to categorically define entire universe of bad
faith is unwise
-Waste claim requires P to show transaction was so one-sided that no business man
of ordinary, sound judgment would conclude corp. received adequate compensation
-only arises in unconscionable cases of irrational squandering or giving away
-corollary to BJR protecting all decisions "attributable to any rational business
purpose"
Analysis:
-Just b/c Ovitz was reimbursed for expenses and given proprietary
information before becoming president doesn't mean he was a de facto officer
owing fiduciary duties
-Ovitz's actions before assuming office were just preparation activities
-Claim that full board was required to approve OEA rebutted by DGCL
-Due care analysis: compare "best case" scenario w/ what actually happened
(1) Approving OEA
-what should have happened was committee members given spreadsheet of
all possibilities and consequences, including NFT payments in each of the five
years, and entered into minutes
-committee met twice, first approving OEA's terms except for options (which
were approved at later meeting), considered a "term sheet"
-members knew potential 90M in options from previous calculations
made in previous option grants to other executives and factoring in
the 50M up-front bonus Ovitz demanded as down-side
protection from walking away from 150-200M in CAA
commissions (since signing bonuses contrary to Disney policy, instead
packaged as back- end options)
-despite reality not living up to "best practices," board was still adequately
informed of the potential magnitude of the compensation package, including
options
-reasonable that early termination would produce high severance, b/c
less had been earned in salary to make up for the 150-200M that
Ovitz had foregone
(2) Approving hiring of Ovitz
-many discussions had been held to find a top executive, and Eisner made
the board aware of Ovitz's abilities and the lucrative opportunities he would
have to be lured away from
-therefore directors were fully informed of material facts
-Good faith: chancery court determines actions didn't rise to the level of bad faith
-Eisner had authority to fire Ovitz w/o full board's approval b/c of Disney bylaws
-No cause for Ovitz's termination found by Chancellor and Disney's legal counsel
and committee in good faith relied on this report, Eisner's options were pretty much
limited to firing Ovitz
-Payment of contractual obligation cannot constitute waste, unless contractual
obligation is itself waste
-creating "irrational incentive" for Ovitz to leave falls far short of waste,
motivated by Ovitz's need for compensation for walking away from CAA
-There is no "substantive due care" in the BJR, only procedural safeguards on
decision-making
-irrationality is the outer limit of BJR, which may be functional equivalent of
waste or bad faith
Key Holdings:
-"Best practices" not required by the BJR
-Committee, rather than full board, had power to approve Ovitz pay package
-Waste argument "does not come close"
-Three possibilities for bad faith:
(1) Subjective bad faith- obvious
(2) Gross negligence- rejected (this is just due care breach)
(3) "Intentional dereliction of duty, conscious disregard for one's
responsibilities"
-Still technically open question whether good faith is freestanding fiduciary duty
-how can violation of good faith not violate due care or loyalty?
Securities Act of 1933- impetus was stock market crash 1929, deals w/ primary
markets, but state regulations began as early as the 1800's ("blue-sky laws"-
focused not only on disclosure, but merits of the investment itself: not too
speculative or immoral)
-rejects merit approach in favor of disclosure approach (i.e. "truth in
securities" act)
-§5 registration
Securities Exchange Act of 1934-
-deals w/ insider trading, short-swing profits by insiders, proxy solicitations,
and tender offers
-viewed '29 crash as a result of fraud, abuse, and market manipulation
-§4 creates SEC
-§13 requires 10K's, 10Q's, and 8-K's
-§14 Williams Act governs proxies and tender offers
-§9 prohibits manipulation of security prices
-§10 antifraud provision prohibits manipulative and deceptive devices
-Rules
-Forms
-SEC informal lawmaking
-SEC no-action letters
-but especially in proxy situations, SEC staff might disagree w/ one another
-Case law
-private litigation
-SEC enforcement actions
-SEC
-5 commissioners appointed by president and confirmed by Senate, only 3 of
which from one party (usually president's); most people only deal w/ the staff
-interpretative guidance to private parties, advises Commission as to new
rules, and investigates and prosecutes possible violations of securities laws
-Business lawyers often run afoul of securities laws b/c they don't realize what they
are dealing with is actually a security; registration only necessary if it's a security
-if sued for failing to register a security, first say it's not a security, then say
it's covered by one of the exemptions, then try to settle on the best terms
-fraud cases much easier for plaintiffs under federal securities laws than state
common law
-security defined by list including stock, notes, bonds, evidence of
indebtedness, investment contracts, and any instrument commonly known as
a security, §2(1) of Securities Act
-§2: security must be defined in the list "unless the context otherwise
requires"
-context clause can be used to give courts wiggle room for new,
confusing devices
Robinson v. Glynn (4th Cir. 2003)
Facts: GeoPhone owner Glynn develops cell phone system called CAMA, contact
Robinson to raise capital, who has no telecommunications experience and agrees to
give 1M to perform field test of CAMA; according to letter of intent Robinson pledges
to invest up to 25M if field test works, and Glynn lies to Robinson saying that it does
work
-Robinson receives 1/5 of GeoPhone's shares, which say "shares" and
"securities" on the back, and says can't be transferred w/o being properly
registered under securities laws
-2 of the 7 board members to be appointed by Robinson and he has own
board seat, Robinson also serves as treasurer and executive committee
-Robinson sues under federal securities laws after learning that Glynn lied
about CAMA, saying he comes under the statute b/c his investment was either
an "investment contract" or "stock"
Rule: §10b-5 claim requires fraud in connection w/ security purchase
-"Investment contract" is an investment of money in a common enterprise with
expectation of profit, solely from the efforts of others, S.E.C. v. W.J. Howey Co.
-courts don't apply "solely" part literally, look instead to "economic reality" of
the investment
-active/passive investor: is he "unable to exercise meaningful control over his
investment"?
-"Stock" refers to narrow set of instruments w/ common name and characteristics
-this label applies only when the instrument is called "stock" and bears its
usual characteristics
(1) right to receive dividends contingent upon apportionment of profits
(2) negotiability
(3) ability to be pledged or hypothecated
(4) voting rights in proportion to number of shares
(5) capacity to appreciate in value
Analysis: Indicia of control not just on paper but also in reality: 3 seats, ability to
select consultants, refusal power over unusual indebtedness
-Robinson exercised too much control to be a passive "investment contract"
-Economic reality guides its true nature, not the labels the parties attached to
it
-Don't have the features typical of stocks (share of profits not in proportion to
number of shares, not freely negotiable, etc.)
-LLC's are hard to classify b/c hybrid of corp., general partnerships, and limited
partnerships, so can't make broader ruling as to all of them
-Securities Act prohibits sale of securities unless they're registered w/ the SEC, §5
requires:
(1) security can't be offered for sale through mails or other means of
interstate commerce unless registration statement filed w/ the SEC
(2) securities can't be sold until registration statement has become effective
(3) prospectus (disclosure document) must be delivered to purchaser before
a sale
-SEC only asks whether there are disclosures accurate, not whether it's a
good investment
-registration requires extensive financial and business information
-b/c of cost involved, businesses try to sell securities w/o registering
them
-some either partially or totally exempt from registration requirement
by being either an exempt transaction or an exempt security,
exempted transactions more common b/c more specialized
Doran v. Petroleum Management Corp. (5th Cir. 1977)
Facts: Petroleum Management Corp. (PMC) organized as limited partnership to drill
oil, contacts four people to invest who decline, then contact Doran to invest in PMC
for 125k, sends him production information but the oil wells deliberately
overproduced and sealed for 338 days by Gas Commission and Doran forced to pay
on note he was personally liable for, Doran tries to refund his investment by
claiming rescission for violation of Securities Act
Rule: §4(2)- exemption for private placement transactions, in determining courts
look at four factors:
(1) number of offerees and their relationship to each other and the issuer
-most important and problematic factor, but not dispositive
-number of offerees, not purchasers
-one offeree's knowledge can't substitute for another's lack of
knowledge
-Applicability of §4(2) depends on whether the class of persons
affected need Act's protection, which then turns on the
knowledge of the offerees, SEC v. Ralston Purina Co.
-requires access to both information and investor sophistication,
sophistication can't replace info
-all offerees must have had available the information in a
registration statement
-relationship b/t issuer and offeree more important when issuer
relies on effective access to the relevant information instead
of disclosure of it
(2) number of units offered
(3) size of the offering
(4) manner of the offering
Analysis: First factor is present as to number of offerees (only 8 offerees), but the
relationship question is still unresolved:
-Did investor have access to information plus an ability to understand that
information?
-some relationships can provide access, ability depends on investor's
background or economic bargaining power
-Regulation D (rules 501-506) relied on by those that try to use §4(2)'s imprecise
language
-if no more than 1M raised, may sell to unlimited number w/o registration
-if no more than 5M raised, may sell to 35 buyers w/o registration
-if more than 5M raised, may sell to 35 buyers who pass various
sophistication tests
-mostly can't widely advertise, and must file notice of sale w/ SEC shortly
after sale
-limits don't apply to accredited investors (i.e. banks, brokers, wealthy
buyers)
-generally exempt only initial sale, so buyer must find another exemption to
resell
-can rely on §4(1) if not "an issuer, underwriter, or dealer"
-but §2(11): underwriter is someone who buys security "with a view to"
reselling it
-court might even invalidate entire issue's exemption, include original
issuer, if she resells shares to a large number of people
-Reg. D provides protection to issuers using "reasonable care" to
ensure buyers are planning to hold stock themselves by
reasonable inquiry into their plans and disclosing that the stock
is subject to resale restrictions
-§144 allows buyers to resell Reg. D offerings if held for 1 yr and
resold in limited volumes
-Before Securities Act, state common law fraud rules were more stringent: must
prove misrepresentation of a material fact, reliance, causation, scienter, and injury
-limited to amount of loss, only some investors relied on or received
misrepresentations
-But federal laws make it much easier:
-private parties can be plaintiffs, plays role as an important deterrent, as
under §10(b)
-implied private rights under certain Securities Act provisions
-§11 principal express clause for fraud in security sale through registration
statement
-no privity requirement, so can bring in officers, directors, experts, and
others
-Due diligence usually the only viable defense to a §11 claim
-standard of liability is essentially negligence, so reasonable
investigation rebuts
-§12(a)(1) imposes strict liability on sellers, main remedy is rescission
-§12(a)(2) imposes private civil liability on offerors of securities in interstate
commerce, w/ prima facie case consisting of 6 elements:
(1) sale of a security
(2) through instruments of interstate commerce or the mails
(3) by means of a prospectus or oral communication
(4) containing an untrue statement or omission of a material fact
(5) by a defendant who offered or sold the security, and
(6) which defendant knew or should have known of the untrue
statement
-reliance not required
-only deals w/ material misrepresentations or omissions connected to
public offerings, not secondary market transactions or private
placements
-§20 gives power for SEC to initiate civil suit or refer to AG for criminal
charges
Escott v. BarChris Construction Corp. (S.D.N.Y. 1968)
Facts: buyers of convertible debt of bowling alley constructor sues under §11 the
signers of the registration statement (the directors, controller), the underwriters,
and the auditors
-increase in bowling lanes spur rise in sales from 800k in 1956 to over 9M in
1960
-raise 1.68B in public equity offering in 1959, followed by issue of the
debentures
-by 1962 industry collapses, BarChris tries to raise more capital in May but
ends up just filing bankruptcy and defaulting on the debentures
-registration statement overstated sales, EBIT, EPS, assets, etc.
-experts could be auditors Peat, Marwick, BarChris's attorneys Perkins,
Daniels, or underwriters' attorneys Drinker, Biddle & Reath
Rule: §11 requires false statement or omission to be "material" for there to be
liability
-SEC regulations define "material" as information "an average prudent investor
ought reasonably to be informed before purchasing"
-enough information to make an intelligent, informed decision
-not concerned w/ minor inaccuracies or errors of no interest to him, but w/
facts having an important bearing upon the nature or condition of the issuing
corp. or its business
-§11(a): "in case any part of the registration statement, when such part became
effective, contained an untrue statement of a material fact or omitted to state a
material fact required to be stated therein or necessary to make the statements
therein not misleading, any [innocent] person acquiring such security" may sue:
(1) everyone who signed the registration statement (issuer itself signs the
statement)
(2) every person who was a director of the issuer
(4) every accountant, engineer, or appraiser, or any person whose profession
gives authority to his statement, and consensually been named as preparing or
certifying part of the registration statement
(5) every underwriter w/ respect to such security
-§11(b)(3): no one, except the issuer, shall be liable if they satisfy that:
(A) for unexpertised, after reasonable investigation, reasonably believed
statements were true
(B) as expert, after reasonable investigation, reasonably believed that the
expert's statements were true or the registration statement unfairly
represented his statement, or
(C) for expertised, no reasonable grounds to believe that statements weren't
an untrue or material omission, or that it unfairly represented the expert's
statement
[for expertised portions, don't need to reasonably investigate just subject to
negative standard;
for not expertised portions must reasonably investigate and have reasonable
grounds to believe it]
§11(c): "reasonable investigation" evaluated by "prudent man in the management
of his own property"
[what is reasonable depends on the defendant, whether inside or outside,
specialized expertise, but can't just rely on clients b/c they lie to you]
Analysis: Much of the misstatements in the prospectus were material
-1960 information seem too small a misstatement to be material, but 1961
information was
-Only portions of registration statement made on Peat, Marwick's authority was
expertised
-just b/c lawyers prepared the whole statement doesn't make it all expertised
-Peat, Marwick only dealt w/ 1960 data, not 1961, which was noted as
unaudited
Vitolo and Pugliese: president and vice-president, "limited education" who dealt w/
construction
-though probably didn't read disclosures, still responsible for them as board
members
-were present at board meetings, knew that their own loans to the company
were unpaid and depended on the financing proceeds to be paid
-therefore couldn't have reasonably believed the registration statement was
wholly true, and no showing that any investigation was made to clarify what
they didn't understand
Kircher: treasurer and CFO, CPA and "an intelligent man," "thoroughly familiar w/
BarChris's financial affairs," contends he didn't know what registration statements
should contain b/c never dealt w/ them before and relied solely on Grant, Ballard
and Peat, Marwick
-credibility issue: withheld info from Grant, Ballard, even if he hadn't, still
should have known that the expertised portion of the prospectus was
incorrect, blind reliance isn't excused
Birnbaum: lawyer, becomes director shortly before registration statement's
amendments filed, making him liable for the its final form
-didn't participate in management, house counsel attending routine legal
matters
-though may not have known of all the inaccuracies, surely knew about some
which he failed to investigate
-should have known as a lawyer that reasonable investigation was required
Auslander: outside director, before joining board obtained Dun & Bradstreet
financial reports and inquired of BarChris's banks, trusted auditors Peat, Marwick b/c
they were the auditors for his bank
-signed registration statement w/o realizing what it was
-as to expertised portion by Peat, Marwick, protected by reliance
-as to non-expertised portion, not protected b/c should have read prospectus
carefully, which would have shown that Peat, Marwick wasn't responsible for all
the figures
-just b/c Auslander was a new director doesn't mean he's excused: even new
directors, if prudent, would have taken the time to gather all material facts before
signing on
Grant: drafter of registration statements and also a director
-honestly believed everything was true, but should have found out all the
errors in the data given to him by his client that didn't need an audit to discover
-cut-and-pasted statements for debentures were inaccurate as financial
position had changed
-nothing like an audit is required, just check of matters easily verifiable
-liable for everything except audited 1960 figures
Peat, Marwick: auditing expert for the 1960 figures, most of work performed by
Berardi, who was not yet a CPA and was handling his first case as a senior
accountant
-Berardi should have realized that Capitol Lanes existed, a falsely reported
accounts receivable
-further inquiry was necessary, relied on unverified oral statements, fell short
of professional accounting standards
Underwriters: all relied on lead underwriter Drexel, who delegate due diligence to
their lawyers
-All publicly traded companies must file Exchange Act reports
-covered corp.'s register w/ SEC by filing initial Form 10, 10-K, 10-Q, and 8-K
-Exchange Act covers registering class of securities, Securities Act covers
particular offerings
-registering class of securities under Exchange Act triggers other
requirements, like proxy rules under §14, tender offer rules of §13 and §14, and
certain anti-fraud provisions
-Before modern integrated disclosure system, overlap existed in the disclosures
required by the Exchange Act and the Securities Act
-inefficient b/c efficient markets hypothesis says all publicly available info
instantly adjusts price
-first look to various forms eligible, then Regulation S-K has substantive
disclosure requirements
-two types of information: information about the transaction and information
about the issuer
-Form S-1, basic registration statement form, requires both
-Form S-3 only requires transaction info: large and seasoned issuers,
regularly provides disclosures so more info is duplicative
Cicero example: merchant, knowing many merchants follow behind him, lands in
famished country; duty to disclose?
-why arrive first? b/c first merchant was smarter, better access to info, faster
ships, assume more risk, incur higher costs, sabotage
-efficiency vs. fairness
Types of Insiders
-true insiders (directors and officers)
-temporary insiders (outside counsel, consultants)
-misappropriators (family members, bankers, lawyers, employees of certain
service providers)
-don't have fiduciary or confidential relationship, even temporarily, but
still come into contact w/ confidential or inside information
-tippees (receive inside info from insiders or misappropriators)
Goodwin v. Agassiz (Mass. 1933)
Facts: In May 1926 Cliff Mining Company directors and officers Agassiz and
MacNaughton buy 700 shares of Cliff Mining from Goodwin;
-geologist theorizes that copper exists on company land and directors
purchase options on adjoining land through related company and secretly
purchase Cliff Mining shares
-directors had material knowledge that Goodwin didn't have and didn't it
disclose to him
-plaintiff only knew after hearing in newspaper, wouldn't have sold if he knew
about geologist
Rule: Directors have position of trust in relation to corporation, but no such relation
w/ individual SH's
[old majority rule: D's and O's can trade w/ SH's w/o disclosing material information
"special circumstances" rule (or special facts doctrine): duty to disclose might be
imposed when there were special circumstances, most importantly concealment of
defendant's identity and failure to disclose information having dramatic impact on
price, Strong v. Rampede
"minority" rule: insiders have duty to fully disclose material information when
buying shares from SH's, Oliver v. Oliver
-by late 1930's, special circumstance or minority rule followed in majority of
states]
-Unique knowledge of directors require full attention to fair dealing when directly
buying or selling stock
-fiduciary duties can't be so strict that no one can fulfill them
-but directors personally seeking out SH's to sell him shares w/o disclosure is
closely scrutinized
Analysis: Buying or selling shares on impersonal exchange is too difficult to actually
go out and track down the opposite party to make disclosures
-No fraud is found in the allegations
-theory was only nebulous; "at most a hope, possibly an expectation"
-premature disclosure may have caused suits from those thinking the theory
was correct
-directors made no misrepresentations and no facts required them to disclose
theory
-plaintiff was sophisticated investor
-Disclosure wouldn't have harmed Cliff Mining Co., just another mining company
owned by the directors
-Texas Gulf Sulphur raises liability for insiders, while Dirks decreases it for tippees
-Chiarella v. United States (U.S. 1980): printing company worker held not liable
under §10(b) and Rule 10b-5 b/c duty to abstain only arises from relationship of
trust b/t SH's and employees, Burger's "misappropriation" dissent later appears in
Hagan
Dirks v. Securities & Exchange Commission (U.S. 1983)
Facts: Dirks, officer of broker-dealer firm, informed from former Equity Funding
officer Secrist that Equity Funding is involved in fraudulent practices
-Dirks uncovers evidence of fraud from interviewing employees, tells WSJ and
some of his clients
-As stock price falls from 26 to 15 in two weeks, trading stops, SEC files
charges, WSJ publishes
-Dirks investigated by SEC but only censured due to his role in exposing the
fraud
Rule: In re Cady, Roberts & Co.: individuals other than insiders can be obligated to
disclose or abstain
-purpose of securities laws to stop "use of inside information for
personal purposes"
-Chiarella: two elements establishing Rule 10b-5 violation:
(1) relationship affording access to inside info intended only for a
corporate purpose
(2) unfairness of allowing an insider to take advantage of that info w/o
disclosure
-duty to disclose doesn't arise from "mere possession of nonpublic
market information"
-no duty to disclose where trading person wasn't a fiduciary
-otherwise, would impose general duty on all market
participants
-only some people, in some situations, cannot trade on nonpublic
material information
-law doesn't require equal information among all traders all the
time
-analyst's job is to try and get a leg up
-Santa Fe Industries: not all fiduciary duty breaches connected to securities
comes within 10(b)
-must be "manipulation or deception" involved
-so insider liable for insider trading only when he fails to disclose and
trades, making "secret profits"
-Tippee's duty is derivative from the insider's duty
-arises from his participation after the fact in the insider's breach of fiduciary
duty
-what makes it a breach is not the nature of the info but the way it was
received from insider
-purpose of the disclosure crucial, Cady
-if no personal benefit to insider, no breach by him and no derivative
breach by tippee
-Tippee assumes fiduciary duty to SH's not to do insider trading only when:
(1) insider has breached his fiduciary duty to the SH's by disclosing the info to
the tippee, and
(2) the tippee knows or should know that there has been a breach
Analysis: Dirks was a stranger to Equity Funding and didn't take actions inducing
SH's to repose trust or confidence in him, no expectation of confidence, nor
misappropriation of information
-Secrist didn't violate Cady duty to Equity Funding SH's b/c he didn't receive
any personal benefit by revealing the fraud, but motivated by desire to expose
the fraud
-therefore no derivative liability
-Can be difficult to prove a personal benefit in connect with a disclosure
-now Regulation FD creates non-insider-based restriction on selective
disclosure: if public corp. discloses info to market professionals or securities
holders, must disclose simultaneously (if intentional) or promptly afterwards
United States v. O'Hagan (U.S. 1997)
Facts: O'Hagan is partner in firm representing Grand Met in tender offer for
Pillsbury, buys many out-of-the-money call options and shares w/ funds embezzled
from other clients' accounts, appeals court says 10b-5 liability can't be based on
"misappropriation theory"
Rule: traditional insider trading theory- 10(b) and 10b-5 violated when insider trades
on material, nonpublic information, which is "deceptive device" b/c breaches
relationship of trust b/t SH's and insiders
-traditional theory applies to both permanent and temporary insiders
-insider takes advantage of uninformed SH's
-"misappropriation theory": fiduciary duty owed to source of the information, under
this theory the fiduciary's self-serving use of the info defrauds the principal of the
exclusive use of the information
-instead of fiduciary relationship b/t insider and purchaser or seller, this is
based on fiduciary relationship b/t fiduciary and source of info
-misappropriators deceive principal by secretly converting his info for
personal gain
-full disclosure negates wrongdoing under misappropriation theory
-but still possible liability under state law breach of duty of loyalty
-deception consummated when securities bought or sold, not when
info received
-protects securities markets from abuses by those owing duty to source, but
not to corp. SH's
-Exchange Act's purpose is to insure honest securities markets and promote
investor confidence
-§14(e) of the Exchange Act: similar to §10(b) except deals w/ tender offers, not
securities transactions
-doesn't require breach of a fiduciary duty for liability
Analysis: Shouldn't treat lawyers differently depending on whether they work for
bidder or target firm
-Rule 14(e)-3(a) is a "means reasonably designed to prevent" fraudulent trading
-prophylactic measures, b/c its mission is to prevent, usually is broader than
the core activity
-way around difficult problem of proving breach of duty of confidentiality, or
other duty
-US v. Chestman: chain of insiders giving inside info to relatives and friends, but
familial relationship alone didn't create a fiduciary relationship
-SEC responds w/ Rule 10b5-2, providing 3 situations where person has
fiduciary duty for purposes of the misappropriation theory: (1) person agrees to
keep info confidential, (2) two people having pattern of sharing confidences such
that recipient knows or reasonably should know that speaker expects
recipient to maintain info's confidentiality, and (3) person receives or obtains
material nonpublic info from a spouse, parent, child, or sibling
-Trading on the basis of nonpublic info vs. Trading while in possession of such info
(i.e. knew the info but was going to sell anyway for medical bills)
-SEC Rule 10b5-1 effectively makes this not matter; subject to narrow
exceptions, one is deemed to have traded "on the basis of" material nonpublic
info if aware of info at the time of the trade
-Securities Act contains prophylactic §16(b): officers, directors, and 10% SH's must
pay to the corp. any profits they makes within six-month period from buying and
selling firm's stock
-smaller group of insiders than under Rule 10b-5
-no tipping liability, no misappropriation liability, no constructive insiders
-SoL of two years, can be brought by SH within 60 days if demand refused,
and must be officer, director, or 10% owner at both purchase and sale
-easily administered but underbroad as well as overbroad
Reliance Electric Co. v. Emerson Electric Co. (U.S. 1972)
Facts: Emerson acquires 13.2% of Dodge for 63/share, but when Dodge engages in
merger talks w/ Reliance, Emerson wants to get out
-upon general counsel's advice, Emerson sells down to 9.96% at 68/share,
then sells rest at 69
-Emerson first claims not liable at all b/c not 10% owner at time of sale, but
appeals court affirms lower court holding that statute satisfied if purchaser
became 10% owner by buying
-only second sale at issue, alleged part of a predetermined plan to
circumvent §16(b)
Rule: §16(b)- corp. may recover profits by owner of more than 10% within six-month
period if held more than 10% at both purchase and sale
-statute's arbitrary and sweeping coverage deemed necessary to insure
optimum prophylactic
-easy administration, cuts down on speculative abuses by reducing
difficulties in proof
-objective standard ignores intent of the insider or existence of actual
speculation
-but also underbroad: no liability if not an "insider" or sells more than six
months later
-10% owners can just sell little bits off until holdings are less than 10%
Analysis: Can permissibly game around the six month requirement by waiting, so
should also be allowed to game around the 10% requirement by selling in bits
-Narrow interpretation meant to compensate for the broad statutory
language? (allows gaming)
-Form over substance: if §16(b) is to be applied strictly, should be strict both ways
Foremost-McKesson, Inc. v. Provident Securities Company (U.S. 1976)
Facts: Provident decides to liquidate by selling off assets, agrees w/ Foremost that
Provident will give 2/3 of its assets for 4.25M cash and 49.75M in Foremost
convertible debt, immediately convertible into more than 10% of Foremost's
outstanding common stock
-closes asset sale on October 15, Provident enters contract w/ underwriters to
sell debentures on Oct. 21, on Oct. 24 Provident distributes 7.25M debentures to
SH's, falling under 10%, then on Oct. 28 sells rest of the debentures to the
underwriters
Issue: Does "at the time of purchase" in §16(b) mean "before" or "immediately
after" the purchase?
Rule: §16(b)
Analysis: Before the purchase
-Congress thought all short-swing trading by insiders vulnerable to abuse b/c of
their close involvement
-but trading w/ mere SH's viewed as abuse-prone only when size of their holdings
afforded potential for access to corp. information
-don't want to unduly restrict SH transactions
-By same logic, should match sales that bring investor below 10% b/c "before", not
"immediately after"
-if meant to deter abuse by influential SH's, divesting all of your shares
shouldn't be treated differently, at least not more favorably, than divesting
less than all your shares
-purchase to get to 10% isn't matched, but selling to go below 10% is
matched
§16(b)
-Issuers: applies only to companies registering their stock under '34 Act, including
companies w/ stock traded on national exchange and companies w/ assets of at
least 10M and 500 or more SH's
-Officers: officers w/ policy-making functions (Rule 16a-1(f))
-can't pair w/ trades before appointment, but can pair w/ trades after
appointment (Rule 16a-2)
-don't get inside info before appointment, but still has inside info after
appointment
-can't resign just in order to commit insider trading, unless waits out
the six months
-Deputization: if X's employee serves as a director for Y, X may be liable for profits
on Y's stock within six-month period
-Stock classes and convertible debentures: under statute to hold 10% of any class
of statute, not necessarily the company's total stock
-applies only to equity securities, including convertible debt but not other
kinds of debt
-Rule 10b-5 applies to all securities, not just equities and convertibles
-once 10% holder for one class, accountable for profits from sales on all
classes
-but different classes of stock not fungible w/ each other
-Litigation: much of it fueled by lawyers, not SH's, in order to claim attorney's fees
-Matching stock: courts match sales w/ purchases however they want, not following
FIFO but matching lowest purchase w/ highest sale to achieve highest profit
-courts interpret statute to maximize gains for the corp.
-but still must be matched within six months
-Unconventional transactions: Exchange Act defines "sale" very broadly (every
disposition for value), but certain transactions are not sales, like "unconventional
transactions," determined by looking at three factors, Kern County Land CO. v.
Occidental Petroleum Corp. (U.S. 1973)
(1) whether transaction is volitional
(2) whether transaction is one over which beneficial owner has any influence,
and
(3) whether beneficial owner had access to confidential info about transaction
or issuer
-Several different situation that might give rise to D&O liability (torts, derivative
suits, employee, customer, competitor)
-Risk of liability may be small, but potential personal liability is huge to the
individual
-If allowed to buy insurance to get around good faith, why not allow them to
indemnify directly?
-can circumvent even more by writing their own policy
-Value of right to reimbursement depends on how favorable the current board is to
the individual and the firm's cash flow position
-§145(a) allows indemnification for judgment and expenses of third party suits, (b)
for derivative suits only allow indemnification for expenses, and if liable to the corp.
only w/ judicial approval (rare that there will be judicial approval if bad faith found)
-both (a) and (b) require good faith and actions "reasonably believed to be in
or not opposed to the best interests of the corporation"
-permissive statutes, power but not the requirement to indemnify
-§145(c): defendant must be reimbursed if successful
-not permissive
-(a) or (b) for unsuccessful defendant
-§145(e) allows advancement of expenses if defendant agrees to repay if
unsuccessful
-Sarbanes-Oxley prohibits loans by corp. to officers and directors (unsure how
this affects (e))
-§145(g) allows corp. to get liability insurance
-method of getting around "good faith" requirement
-§145(f) doesn't restrict defendant's other right to indemnification
-allows written agreements going beyond the statute
-confusion addressed in Waltuch
-Three options w/ the same effect (defendant pays nothing personally):
(1) D not liable to corp.
(2) D is promised indemnification
(3) D is insured against liability
-But can't indemnify against intentional misconduct, violations of duty of loyalty or
good faith, §174 unlawful dividends, or transactions where they received improper
personal benefit
-applies only to directors
-officers also subject to duty of care, but denied exculpation by charter
provision
-102(b)(7) only applies to people acting as a director if both director
and officer
-102(b)(7) is an affirmative defense, at common law corporate employees
were indemnifiable but not directors
-but today all states have statutes allowing some director
indemnification
Waltuch v. Conticommodity Services, Inc. (2d Cir. 1996)
Facts: Silver trader Waltuch sued by angry silver speculators alleging fraud and
market misconduct, all suits settled and dismissed w/o prejudice after
Conticommodity pays 35M to suitors w/o any contribution by Waltuch
-Waltuch pays 1.2M for legal expenses and another 1M defending a CFTC
enforcement action
-Waltuch claims indemnification required by Conti's articles of incorporation
not requiring good faith, but Conti responds that this bylaw violates §145(a)'s
requirement of "good faith"
-Waltuch claims §145(f) permits indemnification outside confines of
§145(a)'s good faith
-Waltuch also claims §145(c) requires indemnification b/c he was successful
Rule:
-§145(a): corp. has power to indemnify for all expenses but must have acted "in
good faith"
-"indemnification rights may be broader than those set out in the statute, but
they cannot be inconsistent with 'scope' of the corporation power"
-§145(f): indemnification shouldn't "be deemed exclusive of any other rights...
entitled under any bylaw, agreement, vote of stockholders or disinterested directors
or otherwise"
-"other rights" must not go beyond the scope of the statute
-indemnification rights can't be inconsistent w/ §145, Hibbert v. Hollywood
Park, Inc.
-in Hibbert, bylaw indemnifying both plaintiff and defendant directors
consistent w/ §145(a) b/c provision didn't distinguish b/t plaintiffs
and defendants
- these rights can't exceed the "scope" of the statute, Citadel Holding Corp. v.
Roven.
-§145(c): indemnification required if defendant "successful on the merits or
otherwise"
-indemnification mandated when defendant "is vindicated"- broadly equates
to "success"
-moral vindication not required, merely dismissal w/o settlement payment,
however achieved
Analysis: §145(a)'s "good faith" requirement limits the scope of indemnification
powers
-if legislature intended augmenting of powers beyond §145(a)'s scope, would
have expressly done so like it did with §145(g) concerning D&O insurance
-Conti's payment doesn't change the fact that Waltuch's claim was dismissed w/o
him contributing towards any settlement
Citadel Holding Corporation v. Roven (Del. 1992)
Facts: Citadel is holding company of S&L's, Roven was director holding 9.8% of its
stock and enters indemnity agreement purporting to provide reimburse for "any
expense or liability"
-but agreement doesn't cover §16(b) short-swing profit accounting
-agreement requires advance payment by corp. of cost and expenses if
defendant agrees in writing to repay if later determined not entitled to
indemnification by the agreement
-Citadel files §16(b) claim against Roven
Rule: §145(e) allows corp. to advance costs of defending a suit
-Corp. obligations under both the statute and agreement subject to a
reasonableness requirement
Analysis: Agreement doesn't condition advancement upon actual right to
indemnification
-required to provide all expenses initially, even if sure to be owed back later
-Citadel not required to advance unreasonable expenses, so protected from
defending absurd or unrelated proceedings
Proxy Fights
-Corp. holds annual meeting to elect directors and vote on important matters
-most investors in public firms don't own enough shares to make it
worthwhile to get informed and go to the SH's meeting to vote
-therefore usually depend on the proxies
-SH meetings usually quiet unless insurgents are trying to control firm by
electing own directors or other matters of basic strategy or up for vote
-proxy fights used to be over social responsibility, not it's about
corporate governance
-proxy fights gave way to tender offers, but as defenses were mounted
against tender offers proxy fights came back as a way to
supplement larger tender offer efforts
-Allowing incumbents, but not insurgents, to solicit proxies w/ corporate funds is
cause for concern
-but also shouldn't allow all 1-share owners to deplete corporate assets
-not allowing any funding of proxy solicitations w/ corporate assets might
leave SH's uninformed
-expense of proxies diminishing w/ technological advances
-§14(a): "It shall be unlawful for any person, by use of the mails or by any means or
instrumentality of interstate commerce or of any facility of a national securities
exchange or otherwise, in contravention of such rules and regulations as the
Commission may prescribe as necessary or appropriate in the public interest or for
the protection of investors, to solicit .. any proxy ... in respect of any security ...
registered pursuant to Section 12 of this title"
-what is a "solicitation"?
-includes not only "direct requests to furnish, revoke or withhold
proxies, but also ... communications which may indirectly
accomplish such a result or constitute a step in a chain of
communications designed ultimately to accomplish such a result" Long Island
Lighting Co. v. Barbash (2d. Cir. 1985)
-after seemingly broad jurisdiction w/ possible First Amendment
implications and other issues, SEC has passed many exemptions
to whittle it down
-i.e. public statements of how SH intends to vote and why,
people not seeking proxy power and don't solicit any
consent, revocation, abstention, or authorization, 10
or fewer, etc.
-an environmentalist group ran newspaper and radio ads critical of the
defendant electrical utility's management and incumbent managers
sued the environmentalists, alleging that their ads constituted a
proxy solicitation
-must provide an annual report: large pamphlet, so big potential for mistakes
-must accompany or precede distribution of the proxy statement
-three-year package of audited financial statements
-brief description of business done
-identity of directors and executive officers, indicating principal
business or occupation
-two years' quarterly range of market prices of an dividends on
common equity
-the annual report to security holders is not deemed to be filed and
part of the proxy statement for liability..
-anyone who "solicits" a proxy must provide a written proxy statement
BEFORE soliciting proxy
-free writing generally permitted thereafter
-§14(a) of 1934 Act prohibits solicitation in violation of SEC rules
-"Solicitation" construed broadly, but Rule 14a-2 says SH doesn't fall under
filing requirement if it doesn't solicit proxies for itself
-Rules require those soliciting proxies to furnish each SH a "proxy statement"
disclosing info and also file it w/ the SEC, more extensive for contested meetings
-For insurgent groups soliciting proxies, Rule 14a-7 causes management to
either give SH list to the insurgents or mail the insurgent's solicitations
themselves
-will usually mail themselves b/c often want to keep the list confidential
-Proxy fights lost cost-effectiveness b/c tender offers more economical
-spending money on proxy fight is expensive and only captures profit in
proportion to their ownership
-most of the benefit goes to free-riders
-hard to get proxies, especially for larger corporations
-no guarantee that spending money will result in a proxy victory
-to profit off of management changes better to buy up majority in a tender
offer
-why incur large risk when you have to share the increased value w/
other SH's?
-more capital required to buy out company than to solicit proxies
-Asymmetrical reimbursement rule for proxy solicitation is slanted towards winning
incumbents, but it's required as an incentive to managers to take over mismanaged
corporations
Levin v. Metro-Goldwyn-Mayer, Inc. (S.D.N.Y. 1967)
Facts: Levin group and O'Brien group vie for control of MGM through proxy
solicitation, Levin complains that O'Brien group used corp. funds to pay for lawyers,
public relations firm, and proxy solicitation firms and used other corp. resources to
help solicit proxies, seeking injunctive relief and 2.5M payment to MGM, each group
has distinct management philosophies
Rule: SH's should be "fully and truthfully informed as to the merits of the
contentions of those soliciting"
-Injunctive power shouldn't be exercised to "unduly influence a SH's [proxy]
decision"
-question is whether illegal or unfair means of communication are being used
to solicit proxies
Analysis: Even if present management has succeeded, whether to keep them
depends on the SH's
-Means used not found to be "illegal or unfair"
-use of MGM funds and retention of proxy firms were all disclosed in the
proxy statement
-125k above and beyond amounts normally spent in proxy solicitations
weren't excessive
[-maybe b/c MGM so big- 251M total assets and 185M gross income in
1966]
-didn't violate any statute or SEC rule or regulation
Rosenfeld v. Fairchild Engine & Airline Corp. (N.Y. 1955)
Facts: 106k of corp. funds spent by old board for soliciting proxies and 28k
remaining expenses reimbursed to old board by new board for reasonable fees
-payment of 127k to new board approved by 16 to 1 shareholder vote
-lower court finds group differences were policy-based not personal-based
(executive employment contract main point of contention)
-challenging SH concedes the charges were fair and reasonable but alleges
that they weren't legal charges to be reimbursed
Rule: Management can tap corporate treasury for "reasonable expenses" of
soliciting proxies to defend its position in a "bona fide policy contest"
-proxy solicitation necessary to secure a quorum and to inform SH's
-must use corp. funds to defend control against insurgents w/ ample funds
-For a contest over policy, not a "purely personal power contest," corp. directors
have the "right to make reasonable and proper expenditures" to persuade
taxpayers for policies which they believe in good faith to be in the corp.'s best
interest
-but can't use corp. funds for individual gain, private advantage, policies not
in corp.'s best interests, or unfair or unreasonable expenses
[Can use corp. funds for proxy solicitations if:
(1) expenses are reasonable
-disclosure statements to SH's
-telephone solicitations
-in person visits to major SH's (wining and dining, private jet to bring to
headquarters)
-reasonableness can depend on size: larger investors might require
closer contact
(2) contest involves "policy" questions and not a "purely personal power
contest"
-but how to distinguish?
-policy and personnel usually spill into one another
-will always be able to make up some kind of policy dispute
For insurgents:
(3) must be successful
(4) SH's must ratify the payment
-if enough proxies to win director seats, probably will have enough to
ratify payment
-just requires more disclosures, so might offer an additional grounds to
sue on]
Analysis: Reimbursement allowed as fair, reasonable, policy-based, and believed to
be in best interests
Dissent: Not all of the solicitation costs were incurred to inform the SH's but to
entertain and transport SH's; SH's only meant to ratify reimbursement to the new
board not the old board
-when directors use corp. money for personal purpose, burden on directors to
show reasonable
-believes burden should be on the directors to prove their expenses were
reasonable and
related to the informing the SH's
-for unanimous SH approval, doesn't matter if action doesn't have a corporate
purpose (b/c no one will file a derivative suit)
-but for only majority approval, action may be adjudged wrongful in a
derivative suit if no
corporate purpose
-impossible sometimes to distinguish policy and personal motivations
-even a purely personal power contest will claim some color of policy
dispute
Typical Annual Meeting
-Nominating committee of the incumbent board of directors nominates a slate of
directors to be elected at the next annual meeting
-Incumbent board identifies other issue to be put to vote (some required by law)
-At company expense: management prepares proxy statement and card,
management solicits shareholder votes (typically w/ aid of proxy solicitor)
-A shareholder (aka the insurgent) solicits votes in opposition to the incumbent
board of directors
-electoral contests: insurgent runs a slate of directors in opposition to slate
nominated by incumbent board
-issue contests: SH solicits votes against some proposal (i.e. to vote no
against merger)
-SH appoints a proxy (aka proxy agent) to vote his/her shares at the meeting
-Appointment effected by means of a proxy (aka proxy card)
-can specify how shares to be voted or give agent discretion
-revocable
-proxy card requirements (mostly Rule 14a-4)
-must identify each matter to be voted upon
-may give discretionary authority to vote in the proxies discretion on
other matters that may come before the meeting, but not elections to
office for which a bona fide nominee is not named
-for, against, and abstain boxes required for each matter other than
election of directors
-for and withhold authority boxes for election of directors so that a SH
may withhold authority to vote for individual directors
-proxies may be revoked and if more than one proxy is given,
-etc.
Shareholder Proposals
-Rule 14a-8 allows qualifying SH's to put a proposal before their fellow SH's
-can have proxies solicited in favor of them in the company's proxy
statement
-expense thus borne by the company
-requesting a report seems unproductive, but it's better than just writing a
letter, and it's a way to suggest to management how SH's feel about issues
-Likely proponents of SH proposals:
-hedge and private equity funds (proposals to make company more
profitable)
-pension funds: union (i.e. AFSCME) and state and local employees (i.e.
CALPERs)
-individual activists (aka Lovenheim)
-charities
-Current issues of SH proposals generally fall into two categories
-CSR corporate social responsibility (global human rights, discrimination,
environment, etc.)
-governance (more important in the wake of the recent economic crisis )
-average votes for governance proposals are 24% and 7% for social proposals
-Responses:
-attempt to exclude on procedural or substantive grounds (must have specific
reason to exclude
that is valid under Rule 14a-8)
-procedural standards:
-proponent doesn't meet ownership/format guidelines
-proposal not timely
-issuer must provide proponent w/ opportunity to cure most
errors within 14 days after submission (relating to format, not
timeliness or ownership/format)
-substantive reasons:
-improper under law of issuer's domicile
-person grievance/special interest
-management functions
-substantially implemented
-and others
-not really a bright-line rules
-include w/ opposing statement (board recommends to vote against)
-negotiate w/ proponent (wide range of possible compromises)
-adopt proposal as submitted
Process of excluding:
-management files a notice of intent to exclude w/ the SEC accompanied by
an opinion of counsel if any of the stated reasons rely on legal issues
-under Rule 14a-8(f), management must notify the SH-proponent of
remediable deficiencies in the proposal and provide an opportunity for them
to be cured
-a copy of the firm's notice and statement must also be sent to the proponent
-Staff level action:
-staff determines can be excluded: issue a no-action letter
-staff determines should be included: notify the issuer of possible
enforcement action if the proposal is excluded
-intermediate position: proposal not includible in present form, but can be
cured
-Review:
-commission
-court
-Eligibility:
-Rule 14a-8(b)(1): proponent must have owned at least 1% or 2k (whichever
is less) of the issuer's securities for at least one year prior to the date
-Rule 14a-8(c): only one proposal per corporation per year
-no limit on how many companies a proponent can submit proposals to
14a-8(h) if the proponent fails to show up at the meeting to present the
proposal in person, the proponent will be ineligible to use the rule for the
following two years
-Per Rule 14a-8(i)(12) a proposal can be excluded if it (or a substantially
similar one) was submitted:
(1) once during the preceding 5 years and got less than 3% of the vote
(2) twice in the preceding 5 years and got less than 6% of the vote the
last time it was submitted
(3) 3 times in the preceding 5 years and got less than 10% of the vote
the last time it was submitted
-Precatory (i.e. nonbinding) phrasing
-Why?
-Primary reason: some proposals that are excludable if phrased as a
requirement must be included if phrased as a request
-Rule 14a-8(i)(1): "If the proposal is not a proper subject of
action for shareholders under the laws of the
jurisdiction of the company's organization"
-it must be an action which it is proper for SH's to initiate (i.e.
CA v. AFSCME)
-look to state law to decide that question (e.g., DGCL 141(a))
-Also want SH's to have input, but not necessarily to run the company