The Law of Corporations and Other Business Organizations

Lecture Notes

The Public Corporations

1. A public corporation is a corporation that
has shares listed on a national securities
exchange or regularly traded in a market
maintained by one or more members of a
national securities association. The term
public corporation may be used synonymously
with publicly held corporation
and publicly traded corporation. Public
corporations have a public market for
their shares, regardless of their size.
2. Securities that are offered and traded
publicly are subject to federal securities
regulations.
3. Any securities offered, sold, or delivered
through any means of interstate commerce
are considered to be part of a public
offering and must first be registered in
accordance with the Securities Act of
1933 and any applicable state securities
law.
4. When the shareholders and directors of a
corporation decide to offer the corporation’s
stock to the public, it is referred to
as going public.
5. The corporation’s first public offering of
its stock is referred to as an initial public
offering (IPO).
6. Corporate shareholders and directors typically
decide to offer their stock for public
sale to take advantage of the capital generated
from the sale of the stock.
7. Disadvantages to going public include
the loss of corporate control by the current
shareholders and the cost.
8. Initial public offerings tend to be more
popular when stock market values and
investor optimism are high. In times
when market values and market confidence
are lower, the number of initial
public offerings tends to decline.
9. After the decision is made to take a corporation
public, the issuers of the stock
typically enter into an underwriting
agreement. The underwriters agree to sell
the shares of the corporation to dealers
for resale.
Securities and Securities Markets
10. Shares of stock, bonds, notes, and any
documents showing a share in a company
or a debt owed by a company or a government
are usually included in the definition
of the term securities.
11. The U.S. Supreme Court has defined a
security as any investment in a common
enterprise from which the investor is “led
to expect profits solely from the efforts of
a promoter or a third party.”
12. Securities of a public corporation may be
traded at a stock exchange or over the
counter.
13. Traditionally, stock exchanges were actual
physical locations where securities
were traded by exchange members on the
exchange floor. In recent years, with the
advent of online trading, not all exchanges
use exchange floors for the trading of
stocks and commodities.
14. The New York Stock Exchange (NYSE)
trades the largest volume of stock, and is
generally considered to be the most prestigious
exchange. It sets listing standards
that include a minimum shareholder distribution,
minimum number of shares
traded, and minimum assets and revenue.
Trading on the New York Stock Exchange
has always taken place on a trading
floor where qualified floor brokers
and specialists buy and sell stock in an
auction style. In recent years, the NYSE
has moved to a hybrid market that automates
much of what the brokers and
dealers do, although there is still trading
on the floor of the New York Stock Exchange.
15. When the National Association of Securities
Dealers Automated Quotation
(NASDAQ) system opened in 1971, it
was not considered a stock exchange, but
rather an automated quotation system for
over-the-counter stocks. With no trading
floor, the NASDAQ served as a new
model for the stock exchanges, and in
2006, the NASDAQ moved from a national
securities association to a national
securities exchange, falling under the
rules of the Securities and Exchange
Commission.
16. Stock exchanges and the NASDAQ are
both self-regulated. They are also both
subject to the Securities Exchange Act of
1934.
Securities and Exchange Commission
17. The Securities Exchange Act of 1934
created the Securities and Exchange
Commission (SEC), which is headed by
five presidential appointees.
18. The primary mission of the SEC is to
protect investors and maintain the integrity
of the securities markets.
Federal Regulation of Securities Offerings
under the Securities Act of 1933
19. The Securities Act of 1933 was the first
significant federal legislation to protect
the investor through the imposition of
disclosure and antifraud measures for
corporations issuing securities through
means of interstate commerce.
20. The SEC imposes disclosure requirements
upon corporations that offer securities
to the public through enforcement
of the Securities Act of 1933, which relates
to the initial registration and issuance
of securities through means of interstate
commerce.
21. Section 5 of the Securities Act of 1933
requires that, prior to the issuance of any
securities through interstate commerce,
the issuer must file a registration statement
with the SEC. The purpose of the
registration statement is to disclose the
information necessary to allow investors
to make informed decisions.
22. The prospectus, which constitutes Part I
of the registration statement, contains
important disclosures concerning the
corporation. The prospectus must be furnished
to the purchaser of securities after
the securities have been registered with
the SEC.
23. Section 5(b) of the Securities Act prohibits
the sale of registered securities without
a prospectus that meets the requirements
of the Securities Act.
24. Regulation C allows the use of a summary
prospectus to sell securities of a
registered corporation, as long as the
summary prospectus includes a required
statement indicating that the more complete
prospectus is available.
25. A red herring prospectus may be used
prior to the effective date of a registration
statement. The red herring prospectus
must specifically state that sales may not
be made until the effective date of the
registration statement.
26. Tombstone ads are also used during the
waiting period to announce a securities
offering and to disseminate certain information
regarding the offering. These
tombstone ads, which are frequently
found in the business section of major
newspapers, must follow certain guidelines
and contain certain legends prescribed
by the rules.
27. The Registration Statement (Form S-1) is
filed electronically with the SEC via its
Electronic Data Gathering, Analysis, and
Retrieval (EDGAR) system, along with
the required supporting documents and
filing fee.
28. Registration statements, annual reports,
and other disclosure documents of all
public corporations may be accessed
through the EDGAR database at
http://www. sec.gov.
Exemptions from the Registration Requirements
of the Securities Act of 1933
29. An issue of securities may be exempt
from the registration requirements of the
Securities Act of 1933 because of the
type or class of securities or the specific
transaction involving the securities.
30. Securities that are scrutinized by other
governmental agencies, such as the banking
or insurance commissions, or securities
that are sold to a specific group of informed
investors, often fall under the
category of exempted securities.
31. Exemption from the registration requirements
of the Securities Act does not provide
exemption from the other provisions
of the Securities Act or related securities
regulations, especially the antifraud provisions.
Antifraud Provisions of the Securities Act
of 1933
32. The Securities Act includes several antifraud
provisions to protect investors who
rely on the disclosures mandated by the
Securities Act.
33. Section 11 of the Securities Act of 1933
provides that everyone who signs or contributes
material information to the registration
statement has a duty to provide
complete and accurate information. All
the individuals who sign or contribute to
the registration statement, including the
underwriter and the directors, are responsible
for any misstatements and omissions
throughout the registration statement,
except experts. Experts are responsible
for misstatements and omissions only
in those parts of the registration statement
that they are responsible for having
prepared or certified.
34. Section 12 of the Securities Act of 1933
concerns the prospectus, and is designed
to protect investors from purchasing securities
based on false or misleading prospectuses
or sales pitches.
35. Section 17 prohibits fraudulent conduct
with regard to the sale of, or offer to sell,
securities.
Federal Regulations Imposed on Public
Corporations under the Securities Exchange
Act of 1934
36. The Securities Exchange Act of 1934
protects securities investors and the general
public by regulating securities exchanges
and markets, by requiring periodic
reporting of information regarding
the issuance of securities, and by prohibiting
fraud and manipulation in the trading
of securities.
37. In addition to the registration requirements
under the Securities Act, the Exchange
Act requires the issuer of all nonexempt
securities traded on a national securities
exchange to register those securities
with that exchange. All exchanges
are required to be registered with the
SEC.
38. Pursuant to the Securities Exchange Act
of 1934, all nonexempt public corporations
must file annual (Form 10-K) and
quarterly (Form 10-Q) reports with the
SEC.
39. Form 8-K must be completed and filed
by the issuer of registered securities
when certain pertinent information in the
registration statement changes.
40. The periodic reports required by the Securities
Exchange Act of 1934 are filed
electronically via EDGAR and are available
to the public.
41. The Securities Exchange Act of 1934
provides certain requirements for the use
of proxies and proxy statements.
42. Regulations 14A and 14C require that if
the proxy solicitation is made on behalf
of the board of directors and relates to the
election of directors, the proxy statement
must be accompanied or preceded by an
annual report to shareholders that meets
the requirements of Rule 14a-3.
43. The annual report to shareholders, which
is an important shareholders’ relations
tool, includes the corporation’s financial
statements, a description of the corporation’s
business during the most recent
year, information concerning each director
and officer, and other information required
by Rule 14a-3. The annual report
is designed to promote a positive image
of the corporation.
Antifraud Provisions of the Securities Exchange
Act of 1934
44. Section 10(b) of the Securities Exchange
Act of 1934 prohibits any misleading or
fraudulent means in connection with the
purchase or sale of any security.
45. Insider trading is prosecuted under §
10(b) of the Securities Exchange Act.
Section 10(b) makes it unlawful for an
insider to purchase or sell stock based on
information that has not been released to
the public, thereby taking unfair advantage
of the uninformed investor.
46. When corporate insiders become aware
of nonpublic corporate information, they
must disclose that information to the public,
or they must abstain from acting on
that information. Since disclosure of private
corporate information is usually not
an option to the corporate insider, absten80
tion from trading is usually what is required.
47. Profits made by an insider on the purchase
and sale of securities within a six-month period
are referred to as short-swing profits
and are prohibited under § 16 of the Securities
Exchange Act of 1934.
Sarbanes-Oxley Act of 2002
48. In 2002, Congress passed the Sarbanes-
Oxley Act, also known as the Public Accounting
Reform and Investor Protection
Act of 2002, in response to major corporate
and accounting scandals in the United
States in 2000 and 2001.
49. The Sarbanes-Oxley Act of 2002 subjects
corporations to tighter controls with regard
to their accounting and auditing
procedures, corporate governance, and
reporting requirements.
50. The Sarbanes-Oxley Act established the
Public Company Accounting Oversight
Board (PCAOB), a new entity to oversee
auditors and the audit of public companies.
51. Section 302 of the Sarbanes-Oxley Act of
2002 requires the chief executive officer
(CEO) and chief financial officer (CFO)
of public corporations to certify the 10-K
and 10-Q and similar reports, indicating
the following:
• They have reviewed the report.
• The report is truthful.
• The financial statements included in
the report fairly represent the financial
condition and results of operation
of the corporation.
• They have established and maintained
controls as prescribed by statute.
• They have disclosed to their auditors
and the audit committee any significant
problems with internal controls
and any fraud involving management
or key employees.
52. The Sarbanes-Oxley Act of 2002 also
requires public corporations to appoint a
certain number of independent directors
to the board and to the audit committee in
particular.
53. The Sarbanes-Oxley Act significantly
increases the maximum criminal penalties
that may be imposed on corporate officers
for securities law violations.
State Securities Regulation—Blue Sky
Laws
54. Blue sky laws are state laws concerning
the sale of securities. Blue sky laws coordinate
with the federal securities acts
and are considered to be valid so long as
they do not conflict with pertinent federal
acts.
55. Most states have adopted, at least to a
significant extent, the original Uniform
Securities Act (1956), the Uniform Securities
Act (1985), or the Uniform Securities
Act (2002). However, blue sky laws
vary from state to state, and the laws of
any state where a contract for the sale of
securities is entered into or executed
must be consulted.
State Regulation of Stock Offerings
56. In addition to filing at the federal level,
blue sky laws may require the issuers of
securities to file at the state level.
57. State securities registration is typically
coordinated with the filing of the registration
statements with the SEC, and less
information may be required at the state
level because the information needed will
be of public record with the SEC.
State Securities Regulation—Antifraud
Provisions
58. State statutes also prohibit fraudulent activities
connected with the offer, sale, and
purchase of securities, similar to the antifraud
provisions found in the Securities
Act of 1933 and the Securities Exchange
Act of 1934.
The Paralegal’s Role
59. Corporate paralegals who specialize in
securities law are often very involved in
assisting with initial public offerings,
with blue sky research and filing, and
with preparing and filing the 10-K and
other periodic reports required by the
SEC.
CASE BRIEFS
Carpenter v. United States, 108 S.Ct. 316
(U.S. 1987)
Purpose: This is an example of an insider
trading case prosecuted under § 10(b) of the
Securities Exchange Act of 1934. Although
this case includes several related issues, the
case has been edited to give focus to the §
10(b) charges as discussed in the text.
Cause of Action: Violation of § 10(b) of the
Securities Exchange Act of 1934, violation of
federal mail and wire fraud statutes, and conspiracy
Facts: In the summer of 1982, Defendant R.
Foster Winans (“Winans”) became one of the
two writers of a Wall Street Journal daily column,
“Heard on the Street.” That column discussed
selected stocks or groups of stocks,
giving positive and negative information about
those stocks and taking “a point of view with
respect to investment in the stocks that it reviews.”
Because of the perceived quality and
integrity of the column, the column had an
impact on the market for the featured stock.
Contrary to the official policy and
practice at the Journal, Winans entered into a
scheme in October 1983 with Peter Brant
(“Brant”) and Kenneth P. Felis (“Felis”) to
give them advance information as to the timing
and contents of the column. Both Brant
and Felis were connected with the Kidder
Peabody brokerage firm in New York City.
Brant and Felis were then able to buy or sell
based on the probable impact of the column
on the market. Profits were to be shared. Over
a four-month period, Brant and Felis made
several prepublication trades on the basis of
information given them by Winans for a net
profit of about $690,000.
In November 1983, correlation between
the “Heard” articles and trading in the
Clark and Felis accounts were noted at Kidder
Peabody and inquiries began. Some time later,
the SEC began an investigation. On March 29,
1984, Winans and his roommate, David Carpenter
(who was also charged in the scheme),
went to the SEC and revealed the entire
scheme. An indictment and bench trial followed.
Winans, Carpenter, and Felis were
charged with participating in a scheme to trade
in securities based on information misappropriated
from the Wall Street Journal in violation
of § 10(b) and 32 of the Securities Exchange
Act of 1934 and Rule 10b-5 promulgated
thereunder. They were also charged with
violation of various mail and wire fraud statutes.
All three defendants were also charged
with conspiracy to violate those statutes and to
obstruct justice by their agreement to cover up
and obstruct any investigation of the scheme.
With respect to the § 10(b) charges,
the courts below held that the deliberate
breach of Winans’s duty of confidentiality and
concealment of the scheme was a fraud and
deceit on the Journal. The district court found
Winans and Felis guilty of securities fraud by
misappropriating material, nonpublic information
from the Wall Street Journal in connection
with the purchase and sale of securities,
and of mail and wire fraud. Winans and
Felis were also convicted of conspiracy to
commit such securities and mail and wire
frauds and to obstruct justice. Carpenter was
convicted of aiding and abetting in the commission
of securities fraud and mail and wire
fraud. With a minor exception, the court of
appeals upheld the convictions.
Carpenter, Felis, and Winans appealed
to the U.S. Supreme Court. The appellants argued
that they could not be held criminally
liable for violating, or conspiring to violate, or
aiding and abetting in violating, § 10(b) of the
Securities Exchange Act of 1934, and Rule
10b-5, because they were not corporate insiders
or “quasi-insiders” and did not misappropriate
material nonpublic information from
such insiders or “quasi-insiders.”
Issue: Can the petitioners be held criminally
liable for violating, or conspiring to violate, or
aiding and abetting in violating, § 10(b) of the
Securities Exchange Act of 1934, even though
they were not corporate insiders and did not
misappropriate material nonpublic information
from such insiders?
Holding: Yes, judgment of the lower court is
upheld.
Reasoning: Although the victim of the fraud,
the Journal, was not a buyer or seller of the
stocks traded in or otherwise a market participant,
the fraud was nevertheless considered to
be “in connection with” a purchase or sale of
securities within the meaning of the statute
and the rule. The courts reasoned that the
scheme’s sole purpose was to buy and sell securities
at a profit based on advance information
of the column’s contents. The court
found it irrelevant that petitioners might not
have interfered with the Journal’s use of its
confidential information, publicized the information,
deprived the Journal of the first
public use of the information, or caused the
Journal monetary loss, because the Journal
was deprived of its important right to exclusive
use of the information prior to disclosing
it to the public. The confidential information
was generated from the business, and the
business had a right to decide how to use it
prior to disclosing it to the public.
Merrill Lynch v. Livingston, 566 F.2d 1119
(9th Cir. 1978)
Purpose: This case includes a good discussion
of the applicability to employees of the shortswing
provisions of § 16(b) of the Securities
Exchange Act.
Cause of Action: Violation of § 16(b) of the
Securities Exchange Act of 1934
Facts: In 1972, Merrill Lynch awarded 48 of
its account executives with the title of “Vice
President,” including defendant-appellant William
G. Livingston (“Livingston”). Livingston
had worked for Merrill Lynch as a securities
salesman with the title of “Account Executive”
for several years. Livingston had exactly
the same duties after he was awarded the title
as he did before the recognition. He was not
included in meetings of the board of directors
or the executive committee, and he acquired
no executive or policy-making duties.
Livingston and other salespersons for
Merrill Lynch received some information that
was not generally available to the investing
public, such as the growth production rankings
on the various Merrill Lynch retail offices.
Livingston’s supervisor, a branch office manager,
testified that the information Livingston
received about the company was not useful for
purposes of trading stock in the company.
In November and December 1972,
Livingston sold a total of 1,000 shares of Merrill
Lynch stock. He repurchased 1,000 shares
of Merrill Lynch stock in March 1973, realizing
a profit of $14,836.37.
Merrill Lynch brought suit against Livingston
demanding repayment of the profit he
made on a short-swing transaction in the securities
of his employer in alleged violation of §
16(b) of the Securities Exchange Act of 1934
(15 U.S.C. § 78p [1971]). The district court
held that Livingston was an officer with access
to inside information within the meaning
of § 16(b) of the Securities Exchange Act of
1934 and ordered Livingston to repay the
$14,836. The predicate for the district court’s
decision was that § 16(b) imposes strict liability
on any person who holds the title of “officer”
and who has access to information
about his company that is not generally available
to the members of the investing public.
Livingston appealed the decision to the U.S.
Court of Appeals.
Issue: Is an employee considered an officer
under the meaning of § 16(b) of the Securities
Act regarding short-swing transactions merely
because he holds the title of an officer?
Holding: The Court of Appeals reversed the
lower court’s findings because Livingston was
not an officer with access to inside information
within the purview of § 16(b) of the
Securities Exchange Act of 1934.
Reasoning: The Court of Appeals found that
liability under § 16(b) is not based simply upon
a person’s title within his corporation, but
that it follows from the existence of a relationship
with the corporation that makes it more
probable than not that the individual has access
to insider information. The Court of Appeals
found that insider information under §
16(b) does not mean all information about the
company that is not public knowledge. Instead
it encompasses that kind of confidential information
about the company’s affairs that
would help the particular employee to make
decisions affecting his market transactions in
his employer’s securities.
Livingston did not receive insider information
within the meaning of § 16(b). The
only information that he received was that
generally available to all Merrill Lynch salespeople.
It was not information reserved for
company management, nor did it give him any
kind of advantage in his security transactions
over any other salesperson for Merrill Lynch.