LAW, BUSINESS, &

SOCIETY
11th
Edition

McGraw-Hill

2015 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not
authorized for sale or distribution in any manner. This document may not be copied, scanned, duplicated,
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Learning Objectives

Describe the advantages and

disadvantages of corporations,
partnerships, and limited liability
companies
Identify and explain the business
judgment rule
Explain the relationship between
limited liability and the doctrine of
piercing the corporate veil
9-2

Learning Objectives

Compare and contrast C corporations

and S corporations
Define and describe common stock,
preferred stock, and debt
Identify the main concerns of corporate
governance
Identify some of the goals of the
shareholder rights movement
9-3

Learning Objectives

Define the term initial public offering

(IPO)
Describe the securities registration
process
Compare and contrast the regulatory
roles of the 1933 and 1934 federal
securities acts
Explain the due diligence defense
9-4

Learning Objectives

Describe the fraud-on-the-market

theory of reliance and explain its
importance
Define insider trading
Contrast the classical fiduciary theory
of insider trading with the
misappropriation theory
Describe the tender offer process and
some defenses against it
9-5

Business Entities and Their

Defining Characteristics

Traditional forms of business

Corporations
Partnerships
Sole proprietorships

Hybrid forms of business

Limited liability company (LLC)
S corporations

Traditional corporations
Referred to as C corporations
9-6

Considerations for Evaluating

Business Forms
Formation and nontax costs
Management structure
Limited liability
Transferability of ownership interests
Duration of existence
Taxes
Capital structure
9-7

Corporations

Formation and nontax costs

Promoter or incorporator files articles of

incorporation with state government

Board of directors
Members are appointed by the incorporators
in organizational meeting
Appoint officers and adopt bylaws

Corporations are separate accounting

entities
Required to establish books of account
9-8

Management Structure

Ownership separate from management

Board appoints officers like president,
treasurer, and several vice presidents
Directors and officers have fiduciary
duties to the corporation

9-9

Case: Business Judgment

Rule

Case
Shlensky v. Wrigley
237 N.E.2d 776 (Ill. App. Ct. 1968)

Issue
Shlensky sued the directors on the grounds

of mismanagement and negligence

because of their refusal to install lights at
Wrigley Field

9-10

Limited Liability

Liability of shareholders is limited to

the loss of their investment in the
corporation
Piercing the corporate veil
Application of the doctrine leads to loss of

limited liability in closely held corporations

Elements - Misuse of the corporate form
and unjust result if limited liability is
allowed to stand
9-11

Case: Piercing the Corporate

Veil

Case
Charles E. Wolfe v. United States
612 F.Supp. 605 (D Mont 1985)
affd 798 F.2d 1241 (9th Cir. 1986)

Issue
Corporation and the proprietorship were

operated as a single instrumentality under

the sole control of Mr. Wolfe

9-12

Transferability of Ownership
Interests

Federal securities laws impose

restrictions on the transfer of stock
Buy-sell agreement
Forces a shareholder to offer his or her

stock to the corporation before selling it to

a third party
Common contractual restriction in closely
held corporations

9-13

Duration of Existence

Corporations have indefinite duration

Voluntarily termination
Requires a vote by shareholders
Occurs when the business prospects are

not favorable

Involuntarily termination
Caused by the action of a court or of the

state corporation regulator

9-14

Corporations

Taxes
Subject to taxation in its own right
Double taxation

Capital structure
Equity capital has a long-term horizon
Debt capital can be short- or long-term
Ensure debt covenants are not breached

9-15

Partnerships

Two or more persons who carry on a

business as co-owners
Partnership interest
Equity interest of a partner

Mutual agencies

9-16

Partnerships: Formation and

Nontax Costs

Partnership is a separate legal entity,

distinct from its partners
Creation requires no filing with the
state
Partnership agreement
Contract that creates and governs

partnership

Partnership accounting systems are

most expensive
9-17

Partnerships

Management structure
Not centralized
Partners owe fiduciary duties to each other

Limited liability
Not offered to owners
Partners are jointly and severally liable for

contract obligations and torts

9-18

Case: Fiduciary Duties of

Partners

Case
Veale v. Rose
657 S.W.2d 834 (Texas Ct. of App. 1983)

Issue
Roses partners claimed that he competed

with the firm in violation of the partnership

agreement

9-19

Partnerships

Transferability of ownership interests

Partnership interest cannot be transferred

to a third person without the unanimous

consent of other partners

Duration of existence
Partnership automatically dissolves upon

the death, incapacity, bankruptcy,

expulsion or withdrawal of any partner

9-20

Partnerships

Taxes
Partnership agreement can detach

percentage ownership from stream of

distributions and tax consequences
Double taxation does not apply

Capital structure
Partners are the sole source of equity

9-21

Limited Liability Companies

(LLCs)

Creation requires owners to file articles

of organization with the state
Members interests - Equity interests
Operating agreement can be oral or
written
Minor annual filings and fees are
required

9-22

Limited Liability Companies

(LLCs)

Extremely flexible management

structure
Closely resemble corporations with
regard to limited liability of the owners
and the duration of existence
Closely resemble partnerships with
regard to transferability of ownership
interests and access to equity capital
9-23

Other Hybrid Forms

Limited liability partnerships (LLPs)

Professional limited liability companies
(PLLCs) and professional limited liability
partnerships (PLLPs)
Limited partnerships
Limited liability limited partnerships
(LLLPs)
Series limited liability companies
International hybrids
9-24

Circumstances Favoring a
Specific Business Form

Total capital needed by the enterprise

Venture capitalists seek persons with
great idea who do not have sufficient
resources
Franchisors demand franchisees
operate their franchises in a business
form with limited liability

9-25

Corporate Governance in
Public Corporations

Public corporations have thousands of

shareholders
Board of directors are elected by the
shareholders
Public corporation boards
Inside directors - Senior executives
Outside directors - Not employed by the

company

9-26

Management Pyramid

Corporations have centralized

management
Board of directors is at the apex of the
pyramid
Followed by CEO, vice presidents and
other top officers and executives
Expands through layers of middle
management
Base comprises of rank-and-file employees
9-27

Shareholder Rights
Movement

Shareholders are the owners of the

corporation
Majority rules - Involves the number of
votes required to elect a director
Broker voting - Many shareholders leave
their shares on account with the broker
Proxy access - Rule issued by SEC
permits shareholder groups to submit
nominees for the companys ballot
9-28

Dodd-Frank Act

Requires disclosure of the relationship

between executive compensation and
financial performance of the company
Say on pay provision
Requires companies to put a separate

resolution before the shareholders to

approve the compensation paid to senior
executives

9-29

Initial Public Offerings (IPO)

First offering of equity securities to the
public by a company
Securities Act of 1933

Ensures full disclosure of facts about the

investment opportunity to offerees

Eliminates fraudulent conduct in the markets
Forbids interstate offering of a new security
Until a registration statement has been filed
with and approved by the SEC

9-30

Initial Public Offerings (IPO)

Critical stages of enforcement
Prefiling period
Waiting period
Post effective period

Exemptions
Exempt securities and transactions do not

require registration with the SEC

Exempt securities are issued by
governments, charities, educational
institutions, and financial institutions
9-31

Case: Security

Case
SEC v. W. J. Howey Co.
328 U.S. 293 (1946)

Issue
Howey Company offered a land sales

contract and a service contract to each

prospective customer
Tracts were not separately fenced and
purchaser had no right of entry and no right
to specific fruit
9-32

Secondary Securities Markets

Security issued can be sold through

physical exchange and over-the-counter
market
Securities Exchange Act of 1934
Created SEC and governs the security

trades
SEC needs companies to disseminate
material information to reach general public
SEC can suspend trading in any security
9-33

Brokers and Online Trading

Broker - Intermediary through which

individuals can buy or sell securities
Provide advisory services and assess

suitability of investments for a particular

investor

Online trading services

Less expensive
Leave investors without professional

guidance
9-34

False or Misleading
Statements in Required
Filings
1933
Act
Section-11
establishes liability with

respect to false or misleading

registration statements
No proof of plaintiff reliance on the
content of the registration statement is
required
Due diligence offers defense against a
Section 11 claim
9-35

Case: Due Diligence Defense

Case
Escott v. BarChris Construction Corporation
283 F.Supp. 643 (S.D.N.Y. 1968)

Issue
BarChris filed a registration statement for

new bonds to raise cash when the

company ran into financial problems
Circumstances became grave and BarChris
filed for bankruptcy
9-36

False or Misleading
Statements in Required
Filings
1934
Act
Section-18
establishes liability with

respect to false or misleading

registration statements
Defense offered is that the defendant
acted in good faith
Plaintiff must prove that he or she
relied on the statements

9-37

Fraud

Section 17(a) of 1933 Act and Section

10(b) of 1934 Act
Illegal for anyone to engage in any

practice that defrauds another person

participating in the financial markets

Committed by corporate wrongdoers

Fraud-on-the-market theory

9-38

Case: Fraud-on-the-Market
Theory

Case
Basic Inc. v. Levinson et al.
485 U.S. 224 (1988)
District Court

Issue
Respondents asserted that defendants

issued misleading public statements that

they were injured by selling basic shares at
artificially depressed prices
9-39

Insider Trading

Illegal insider trading occurs when an

insider breaches a fiduciary duty to
shareholders
Section 10(b) of the 1934 Act
Prohibits the use of any deceptive device

in connection with purchase or sale of

securities

9-40

Case: Insider Trading

Case
SEC v. Texas Gulf Sulphur Co.
401 F.2d 833 (2d Cir. 1968)

Issue
Insiders started buying TGS stock when a

discovery hole revealed one of the largest

ore strikes in history
TGS denied the rumors and the stocks kept
exceeding
9-41

Case: Misappropriation
Theory

Case
United States v. OHagan
521 U.S. 642 (1997)
Supreme Court

Issue
OHagan purchased and sold Pillsbury

stock, making a profit of $4.3 million

Used the profits to conceal his previous
embezzlement of unrelated client trust funds
9-42

Short-Swing Profits

Case presumes that insider had

material information and traded on it
unlawfully
Goal
Prevent insiders from taking advantage of

company information to secure short-term

profits

9-43

Private Enforcement

Harmed plaintiffs join together in a classaction lawsuit in civil damage cases

Lobbying against runaway securities
class-action suits yielded good results
Private Securities Litigation Reform Act
Eliminates joint and several liability for

accountants and underwriters

Increased plaintiffs procedural hurdles in
bringing suit
9-44

Government Enforcement

Government can bring suits for aiding and

abetting securities fraud against third
parties
SEC enforces the law by imposing civil
penalties for individuals and corporations
Disgorgement - Forcing defendants to give up

ill-gotten gains

Department of Justice seeks criminal

sanctions for wilful violations of the 1933
and 1934 Acts
9-45

Tender Offers

Offeror announces that it wishes to

acquire a specific number of shares
Participating stockholders must tender
their shares
Hostile takeover - Managements
resistance against tender offer
Resistance tactics
Launch of managements own tender offer
Buy back shares in the market
9-46

Tender Offers
Greenmail

Takeover defenses
Crown jewel - Involves the target company

selling off its most attractive assets

Poison pill

Golden parachutes
Targets officers negotiate to protect

themselves in the event of a takeover

9-47

State Securities Regulation

U.S. operated under a dual regulatory
environment for securities
National Securities Markets Improvement
Act

Preempts state registration requirements for

securities traded on national markets

State securities regulations (Blue sky

laws)
Primarily applicable to solely intrastate

offerings
9-48

International Securities
Regulation

United States is losing its place as the

worlds leading financial center
American securities regulation is the
strongest in the world
Fastest-rising markets make companies
to stay in their home countries
National regulation is increasing in
ways that model U.S. policies
9-49