corporation

I. Formation of corporation
A. The incorporation process
1. Corporation formation time: secretary of state accept the files
2. Model Business Corporation Act (MBCA), requiring four items in the
articles
a. Name: must not be the same or confusingly similar to that of another
corp. incorporated or qualified to do business in the state of
incorporation. The name must include some word or abbreviation
indicating that the business is incorporated, like corporation,
company, Inc.
b. Authorized shares: must state the maximum number of shares the
corp. is authorized to issue
c. Registered agent: the name of registered agent and the address of its
registered office
d. Incorporators: the name of address of every incorporator
3. Optional provisions
a. Statement of purpose
b. Classes and series of shares
c. Director and officer indemnification and liability limitation
4. Amendment of Articles
a. Can be amended at any time
b. Process:
1) The board of directors must recommend the amendment to SHs
2) SHs must approve the amendment
3) Amendment must be filed with secretary of state's office
5. Bylaws & articles:
a. Bylaws governs internal affairs
b. Bylaws are more easily amended than articles
c. If there is conflict of bylaws and articles: use articles
B. Defective incorporation: where the incorporation is defective, there are two
ways to hold a corporation liable to a pre-corporation contract:
1. De facto Corp.
a. If the promoter failed to form a legal corporation because of some
technical defect in the incorporation process, a court may
nevertheless treat the business as a de facto corp.
b. Standard: there was good faith efforts to incorporate the business;
and the putative shareholders carried on the business as though it
were a corp., especially with respect to the transaction in question.
c. No matter whether the third party think it is a corporation or not
 2. Corp. by estoppel: under this, a creditor who deals with a business as a
corporation, and who agrees to look to the “corporation’s” assets rather
than the “shareholders’” assets will be estoppelled from denying the
corporation’s existence.
a. Shareholders may be protected even in the absence of good faith
effort to incorporate on their part (does NOT require good faith).
b. No requirement of misrepresentation, reasonable reliance, change in
position
c. Corp. by estoppel could be found because the third party had dealt
with the firm as though it were a corp. and relied on the firm, not
the individual defendant, for performance.
C. Pros and cons of limited liability
1. Pros:
a. facilitate capital formation
1) permits passive investment
2) allows for diversification of investors
b. enable stock market fungible
2. cons:
a. victims don't get paid fully-limited liability
b. can not eliminate economy risk
c. unfair that has value
d. limited liability create externality
e. inefficiency:
1) limited liability creates the ability to off-load some of the cost to
outside parties.
2) Negative externalities create maker fails to create incentive to
take on more risk
f. contract: limited liability, no pierce the veil
1) protection: insurance, secured transaction, personal guarantee,
huge interest, high rate of loan
g. torts:
1) public corp.: limited liability
2) close corp.: can argue personal liability
II. The corporate entity and Limited liability
A. characteristic of corporation
1. Separation of control and ownership
a. All corporate powers shall be exercised under the authority of the
board of directors, & board manages the business & affairs of the
corporation
b. Inefficiency: use the value not most in favor of ownership, but for the
controller
c. SHs: elect board of directors
d. Board of directors:
 1) Individual directors/board members are NOT agents of the
corporation, so directors acting separately and not collectively as
a board cannot bind the corporation. Only the board itself can act
as a “super- agent” and bind the corporation.
2) Collective procedure is necessary in order that action may be
deliberately taken after an opportunity for discussion and an
interchange of views
B. Sources of law
1. State law
a. State law, of the state of incorporation, governs the corporation
internally.
b. Model Business Corporations Act (MBCA)
c. Delaware Law (DGCL)
2. Federal law
a. (primarily “public” corporations)
b. the issuance and trading of stocks and other corporate securities; do
not preempt state corporate law, but instead place only a limited gloss
on the broader body of state law
3. difference: state law is concerned with the substance of corporate
governance, while federal law is concerned with disclosure and a limited
number of procedural aspects of corporate governance (such as the
solicitation of proxies and the conduct of a tender offer)
4. Internal affair doctrine: a conflicts of law rule holding that corporate
governance matters are controlled by the law of the state of
incorporation.
C. Limited liability
1. Limited liability rule says that, unless otherwise provided in the articles
of incorporation, a shareholder of a corporation is not personally liable
for the acts or debts of the corporation except that he may become
personally liable by reason of his own acts or conduct. MBCA 6.22(b).
2. Limited liability is the default rule & you can try to contract around it
D. Piercing corporation veil:
1. Definition: the shareholders are personally liable for corporation's debt
2. Test
a. Unity of interest between corporation and SHs: There must be
such a unity of interest & ownership that the separate personalities of
the corporation and the individual no longer exist; AND
1) Control (element)
a) control of the corporation by defendant that is so complete as
to amount to total domination of finances, policy, and
business practices such that the controlled corporation has no
separate mind, will or existence;
2) Failure to comply with corporate formalities(consideration)
a) failure to keep separate corporate books and records;
 b) failure to hold periodic meetings of the board of directors
and of the shareholders;
c) failure to appoint a board of directors; or
d) failure to formally issue stock to the shareholders in the
form of share certificates.
3) Commingling of funds or assets (using corporate assets as your
own): If you have a corporation and you only have one bank
account that you use for corporate & personal use
4) Undercapitalization: (consideration)This is when you don’t
leave enough assets in the company to satisfy the debts and
liabilities of the corporation (having less money than what you
would expect the liabilities of the company to be).
b. Promote Fraud and Injustice: circumstances must be such that an
adherence to the fiction of the separate existence would sanction a
fraud or promote injustice. Meaning, if we don’t pierce the veil &
make them liable, then there is some fraud or injustice being
promoted.
1) Intentional undercapitalized
2) Corporate facades to avoid its responsibility to creditors
a) SH's control is used to commit a fraud, wrong or other
violation of plaintiff’s rights;
3. Walkovszky v Carlton
a. The mere fact that a corporation is part of a larger enterprise is
insufficient to justify veil piercing, or so the court opined. Splitting a
single business up into many different corporate components thus will
not result in the controlling shareholder being held personally liable
for the obligations of one of the corporate entities.
b. Fraud can justify veil piercing in appropriate cases, suggested the
court, but Carlton committed no fraud.
c. Court regarded corp. as the shareholder's agent, and according to
prespondeat superior, the SH is liable. But it will cause various
liabilities for SHs.
4. Related doctrine
a. Reverse Veil Piercing
1) Creditor-shareholder- corporation
2) a personal creditor of the shareholder seeks to disregard the
corporation’s separate legal existence.
3) The debts of SH are also the debt of corporation, so you become
the debtor of corporation
4) Payment Priority
b. Enterprise liability
1) Commingling of horizontal assets
2) Almost the same with piercing veil
 3) Difference: as to the unity of interest: no need to have to show
control as PV, only to show other enterprises are siblings of the
corp.

III. The role and purpose of Corp.

A. Purpose:
1. Profits for SHs: a business corp. is organized and carried on primarily
for the profit of the stockholders. The powers of the directors are to be
employed for that end. Dodge v. Ford
2. jobs for employees
3. charity for community: Smith v. Barlow
a. the donation was voluntarily made in the reasonable belief that it
would aid the public welfare and advance the interests of corp. as a
private corp. and part of the community in which in operates.
b. but the donation may not be unreasonable or to a pet charity of the
corporation directors in furtherance of personal rather than corporate
ends.
1) Dodge: merely incidental to SH’s interest for the primary
purpose of the defendant directors
IV. Corporation governance
A. Fiduciary duty of care
1. To whom directors owe the DOC
a. Normally, directors owe DOC to SHs;
b. But, under some circumstances, directors owe DOC to creditors
1) When the corporation is in a line of business in which the
corporation, takes money from clients & holds that money in
trust for the clients, like Financially institutions, banks
2) The company has gone insolvent, bankruptcy
2. Three kinds of breach of DOC
a. Waste
1) Require P to show that the consideration received is so clearly
inadequate that the transaction effectively amounts to a gift of
corporate assets serving no corporate purpose.
2) Court will dismiss claim as long as any reasonable person might
conclude that the deal made sense. The standard of proving waste
is stringent.( rarely successful)
b. Failed to get informed in decision-making. Van Gorkom
1) Directors should be informed prior to making business decision
of all material information and reasonably available to them.
2) “Material”: if a reasonable decision-maker would want to know
before making decision; or if significantly alter the picture of the
decision
a) Reliance on experts: the report should be related to the
decision(experts is about value, decision is about feesable)
 b) Premium: no investigation to know the best price
3) Standard: gross negligence
4) Argument:
a) Reliance on experts:
b) Premium:
c. Failure to oversee the corporation’s activities (supervisory
duties).
1) Oversee Duty
a) Review financial statements, not require day-to day (books)
b) Inquire about the questions revealed by financial statements
c) Have to duty to object and stop; if the illegal conduct does
no stop, to resign
d) In certain circumstances, the duty calls more than objection
and resignation. Sometimes dircs have duty to take
reasonable means to prevent illegal conduct by co-directors;
e) In any appropriate case, this may include threat of lawsuit.
2) DOC of affirmative monitoring
a) If employee violated brefore, then has affirmative
monitoring obligation to make sure employees compaly with
law
b) If some are where employee works, there is tendency that
employee violate law, there should be affirmative monitoring
obligation.
c) Francis: (1) read and understand financial
statements;(2)make reasonable attempts at detection and
prevention of the illegal conduct of other officers and
directors
3) Absolving from liability(Francis)
a) usually a director can absolve himself by informing other
directors of the impropriety and voting for a proper course of
action.
b) However, a director who votes for concurs in certain actions
may be liable to the corporation for the benefit of its
creditors or SHs, to the extent of any injuries suffered by
such persons.
c) A director who is present at a board meeting Is presumed to
concur in corporate action taken at the meeting unless his
dissent is entered in the minutes of the meeting or filed
promptly after adjournment.
4) Delaware:
a) Follow basic business rules
b) Make reasonable efforts to prevent the illegal conduct
 c) Actively monitor only if there is violation of law or area
employees working where there is dangerous probability to
break the law
B. Duty of loyalty
1. No bad faith
a. three kinds of bad faith
1) subject bad faith
2) knowingly violation of law(illegality)
3) intentional dereliction of duty or conscious disregard for one’s
responsibility
bad faith is not exculpable and is not indemnified.
b. Put in place a monitoring system and use it. Directors have a duty
to implement a law compliance system. They will be liable if:
1) They fail to install any kind of reporting or control system; or
2) They install the system but do not pay attention to it (consciously
fail to oversee or monitor it).
3) imposition of liability requires a showing that the directors knew
they were not discharging their fiduciary obligations. Its more
than negligence & is like recklessness (they were reckless in not
installing or not monitoring).
2. No “self-dealing” Flieglen
a. No interested directors transaction or conflict of interest
1) When there is COI
a) Direct Interested Transaction-When a director of a
corporation himself enters into a contract with his
corporation (i.e to sell the corporation land, to give
corporation a loan).
b) Indirect Interested Transaction-Two types:
i. Type 1: When a director of a corporation has a material
financial interest in the transaction (but he doesn’t enter
into the K w/ the corporation himself).-Example: CEO
of ML has an interest in FrogCorp & a transaction or
contract takes place between ML & FrogCorp.
ii. Type 2: When a party that is somehow related to the
Director of a corporation enters into a contract with the
corporation.-Example: ML enters into a K with CEO’s
wife.
2) Plaintiff who is trying to challenge the transaction has the burden
to prove there is a COI.
3) Procedural sanitation: Interested director statute: Conflicted
interest transactions are governed by DGCL 144:
a) Conflicted interest transaction shall not be void or voidable
solely because of the director's conflict or solely because the
director or officer is present at or participates in the meeting
 of the board or committee which authorizes the K or
Transaction, or solely because any such director's or officer's
votes are counted for such purpose, if one of the three
conditions are satisfied:
b) Approved in good faith by vote of SHs. following full
disclosure(material facts and reasonably available).
i. Delaware court: interpret SHs to disinterested SHs.
ii. The burden shifts to the P(SH) to show that the
transaction is so unequal as to amount to a gift or waste
of corp's asset.
c) Approved by a majority of the disinterested directors if
there has been full disclosure of material facts relating
both the transaction and director's COI
a. If approved by majority disinterested SHs, then BJR
standard is applicable.
b. And P(P's burden) can win only by showing they did
not comply with BJR (material facts informed and
reasonably available)
d) If there is no SH or director ratification, then we ask is
intrinsic fair to corp. at the time of it is authorized,
approved?
a. This section applies when 1)/2) is not met
b. Defendant's burden to show fairness

c.

b. No usurpation of Corporation Opportunity: director or fiduciary of

the corporation cannot appropriate the business prospects that the
firm is itself capable of & interested in pursuing.
1) Delaware definition: Broz
a) Financial capability to take the oppor.?
b) Is it in the line of corp's business?
c) Does corp. have interest or expectancy in the opportunity?
 d) Does an officer or director create a conflict between his self-
interest and that of the corp. by taking the opportunity for
himself?
2) Lambert : Lambert thinks these four questions can be combined
to two questions:
a) Financial capability
b) Whether within the barnumber?
c. No unfair controlling SHs transaction (Sinchair)
1) Controlling SHs: no need to exceed 50%; if the remaining SHs
are dispersed, and smaller, than it is controlling SHs.
2) Non-controlling SH can sue either controlling SHs or Board of
Directors(standard are the same)
3) Rule applied in controlling SHs case:
a) Pre-requisite of the test:
i. Parent has received benefit, and
ii. To the exclusion and at the expense of subsidiary
b) must meet the test of intrinsic fairness
i. High degree of fairness, and
ii. a shift in the burden of proof(defendant's burden)

4)
C. Protection of directors from liability
1. Business judgement rule
a. Protect courts from stepping into business judgement; judges are not
expert of business
b. Prerequisite of BJR: DOL+RC
c. Rebutting of BJR: either breach of DOL, or breach of reasonable care
d. Delaware 102(b)(7):
1) Can not apply automatically, it should be included in the articles
of corporation
2) Only applies to directors, not officers
3) Directors can be insulated only for breach of DOC, not DOL
(SHs can sue directors for breach of DOL)
4) It’s affirmative defense. Directors have burden to prove that they
are entitled to expulsion.
 5) The statute limits only the monetary liability of directors.
Equitable remedies are still available.( If SHs sue directors for
breach DOC beyond monetary damages, the director is liable)
2. Indemnification: DGCL§145- Indemnification is when the company
indemnifies the director or board member for losses or any amounts the
director may owe after being sued.
a. Mandatory indemnification:
1) If the director wins in the suit he must be indemnified
b. Permissive indemnification:
1) Derivative lawsuit: subject to good faith
2) If the suit is by a third party & the director loses, then the
company may (but does not have to) indemnify the director even
if he loses. If suit is by 3rd party, then may indemnify if acted in
good faith & in a manner reasonably believed to be in or not
opposed to the best interests of the corporation, & had no
reasonable cause to believe conduct was unlawful

II. Enforcement of DOL: SHs lawsuit

A. Direct lawsuit: Direct Actions are those that the shareholder can bring
directly (alleging a direct loss to shareholder.
1. These causes of action belong to the shareholder in his individual
capacity
2. SHs bring the suit in their own name.
3. Remedy is compensated directly to SHs
B. Derivative lawsuit: A derivative suit happens when the shareholder goes to
court & says I want to compel the corporation to bring a lawsuit against
someone (it’s a suit in equity against corporation to compel it to sue a third
party).
1. Character of derivative lawsuit
a. It is brought by SHs on behalf of corp.
b. Cause of action belongs to corporation since it arises out of an injury
done to the corporate entity
c. Resulting from the less valuable corporation’s value
d. Remedy is compensated to corp. and then to SHs
2. Bases for derivative suit:
a. Breach of duty of care
b. Breach of DOL
c. Waste of corporate asset
3. Pre-requisite of derivative lawsuit:
a. He must have been a SH at the time the acts complained of occurred
b. He must still be a SH at the time of suit
c. He must be fair and adequate representative of corporation’s interest
d. Must make demand(unless excused)
4. Expense payment
 a. If litigation results in substantive benefits to corp., corp. has to pay
P’s litigation fee
b. If D directors succeed, corp. has to pay D’s fee
c. So, P’s lawyer and D can make conclusive settlement, directors agree
to create commitment on board, and directors win. So corp. has to pay
P and D’s fee
5. Whether a lawsuit is direct or derivative lawsuit?
a. Who suffers the loss?
b. Who receives the remedy?
6. Demand requirement
a. Shareholders must first approach the board & demand that the board
pursue the legal action UNLESS it’s futile, in which case demand is
excused
b. When is demand excused? (the demand is futile)
1) Are there any facts that justify reasonable belief that demand
would be futile? (a) can add (b)
a) A majority of the board has a material financial or familial
interest;
b) A majority of the board is incapable of acting independently
for some other reason such as domination or control;
c) The underlying transaction is not the product of valid
exercise of business judgement, so BJR can’t be applied
2) Hypo
a) CEO has interest
b) CEO has interest; 4 insider directors report to CEO. So
4+1=5
c) 8: 4:4, 符合多数
3) “reasonable doubt”: reasonable doubt can be said to mean that
there is a reason to doubt. Reasonable Doubt is akin to concept
that the stockholder has a reasonable belief that the board lacks
independence or that the transaction was not protected by the
BJR. Grimes
4) A stockholder who makes a serious demand and receives only a
peremptory refusal has the right to use the "tool at hand" to
obtain relevant corporate records, such as reports or minutes,
reflecting the corporate action and related information in order to
determine whether or not there is a basis to assert that demand
was wrongfully refused. Grime
5) “tool at hand”: the shareholder can use public sources, media,
corporate books & records & government filings (can’t use
discovery, only tools at hand).
c. What if demand is made of refusal?
1) By making demand, demand is not excused: Once a P makes a
demand on the board, he can no longer come back afterward &
 argue that demand was excused so he should be able to bring the
suit himself.
2) Director’s Refusal is a presumed BJR, the burden is on P to show
wrongful refusal.
3) Only way to file lawsuit: is to show wrongful refusal , that is to
show there is reasonable doubt that prerequisite of BJR is not
met.
4) Whether making a demand?
a) If u make demand
i. Can not claim demand is excused
ii. Will probably be refused
iii. Probably can not show wrongful rejection.
b) If u do not make demand,
i. Dismiss w/o prejudice(second chance)
c) People will probably choose not to make demand. As a
plaintiff, don’t make a demand to the board first. Just file
your lawsuit & tell court you are not going to make a
demand b/c it is excused(futile). If you lose on futility
question, then you make your demand to the board
d. What if demand is excused, but the board seek to dismiss?
1) Whether maintaining is corp’s business, corp control its business
power.( this is director’s fundamental power, not relevant to
BJR). Del.C. S141(a): “The business and affairs of every
corporation shall be managed by or under the direction of a board
of directors, except as many be otherwise provided in this chapter
or in its certificate of incorporate.”
2) Some corporations may create an special litigation
committee(SLC), which is an independent committee of
disinterested directors, to evaluate the claims in the demand &
determine if the corporation should pursue or dismiss the cause
of action. The interested/tainted directors can appoint this
committee.
3) Procedure of SLC: After an objective and thorough
investigation of a derivative suit, an independent committee may
cause its corporation to file a pretrial motion to dismiss in the
court. The motion should include a thorough written record of
the investigation and its findings and recommendations.
Zapata.
4) File a motion to dismiss, showing this lawsuit is actually harmful
to corp. Zapata
5) What the court might consider the SLC’s dismiss(TWO
approaches)
 a) Other states : Court defers to the SLC’s decision under the
BJR as long as the committee was independent & the
investigation was adequate (done in good faith).Burden is on
the plaintiff to try & argue that the SLC’s decision violates
the BJR.
b) Delaware: court looks not only at the procedures used, but
also at the reasonableness of the basis for the committee’s
decision. TWO STEPS
i. Firstly, the court should inquire into the independence
and good faith of the committee and the bases
supporting its conclusions. The corporation should have
the burden of proving independence, GF and a
reasonable investigation.
ii. If the first step is satisfied, the court may, but not need
to, apply its own independent business judgement,
whether the motion should be granted. (only one context
that judge can use bz judgement to decide)
a. Look at the corp.’s compelling interest
b. Taking into consideration matters of law and public
policy
c. Court asks, is this the right decision that the
corporation’s best interest
d. Lambert: court should consider whether the lawsuit
is good or bad? Is there possibility that the plaintiff
would win?
C. Derivative lawsuit flowchart

III. Disclosure and Fairness

A. What is security
1. Specific: notes, stock, treasury stock, security future, bonds,
debenture(first consider)
2. General: investment K
a. Supreme court defines IK as: a contract, transaction or scheme
whereby a person invests his money in a common enterprise and is
led to expect profits solely from the efforts of the promoter or a third
party
b. Test for IK
1) Investment of money
2) In common enterprise
a) >=2 invertors commingle
3) With expectation of profits; almost solely from the efforts of
others
3. Economic reality: investor can not exercise meaningful control over its
investment
4. Hot to define stock: called as stock and has common stock:
a. The right to receive dividends contingent upon an apportionment of
profits
b. Negotiability (freely transferable)
c. The ability to be pledged or hypothecated
d. The conferring of voting rights in proportion to the number of shares
owned
e. The capacity to appreciate in value
5. Hypo for IK:
a. Buy 100% of shares
1) Not common enterprise(different capital mingle )
2) Vote:
b. Only 1 stand, you ad friend buy all, half and half interest. You left it
for friends to run
1) It is general p-ship, not security, because have right to control
c. New country club sell membership, labeled as stock.
1) Although labeled as stock, but it is not stock. Because it has no
common stock characteristic
d. Corporation, buy all stock of the corporation. Run by self.
1) Stock is on the specific list.
2) If labeled as stock and has common stock characteristic, do not
have to look at the test of IK
6. How to decide whether it is security:
a. Whether it is bought from national exchange, it is security, even
though he buys 100%
b. If not buy from national exchange, to see if called as stock and has
common stock characteristic?
c. If yes, then it is security
d. If not, to look at the IK test
e. If the IK is met, then it is security
Corp. P-ship LLC
 Number of 1 or more >1 (partners) 1 or more
residual (SHs) (members)
claimants

Principal ltd Unltd ltd

liabty

Tax at yes No No
entiry level

Formalities Yes - No Yes-articles of

to create articles of organization
corporation

Internal Bylaws of Operating P-ship agreement

affairs corp. agreement

Mgt centralized Decentralized Either :

membership
LLC(members
make decision )
and manager-
management
LLC(board
makes decision)

Transferable Freely Not freely Default: not

freely
transferable
f.
B. Overview of the registration requirement, exemptions, and bases for civil
liability under the Securities Act
1. Security Act of 1933: primary market
a. Registration requirement: SA 5
1) Security may not be offered for sale through the mails or by use
of other means of interstate commerce unless a registration
statement has filed w/ SEC
2) Securities may not be sold until the registration statement has
become effective
3) The prospectus(a disclosure document) must be delivered to the
purchaser before a sale
b. Exemption to registration requirement (not require registration)
1) It exempts some securities entirely: an exempt security need
never be registered, either when initially sold by the issuer or in
any subsequent transaction
2) It exempts some transactions: are one-time exemptions
 a) Eg: if A sells a non-exempt security to B in an exempt
transaction, B is not automatically free to resell that security.
B must either register or utilize another exempt transaction
2. Securities Exchange Act of 1934: secondary market transaction
a. Deal w/ what corporations do on an ongoing basis regarding their
secondary market (meaning what happens to securities after the
company sells them to investors).
1) Focus on mandatory disclosures: 10Qs, 10Ks
2) Fraud prevention: Rule 10b-5 & Section 16
b. What needs to be disclosed (1934 SEA?)
1) Principal forms required for public issuers:
a) 8-K - reports certain material developments or extraordinary
events
b) 10-K - annual report; 10-Q - quarterly report
2) Anti-fraud Liability: SEA Section 10, Rule 10b-5
a) Section 10(b) of 1934 Exchange Act gives the SEC the
power to create rules against fraud committed in the
securities markets.
b) Rule 10(b)5 is the anti-fraud rule.
3. Civil liability 12(a)1+2 P428+21
C. Elements of Rule 10b-5
1. Misstatement or omission: Requires deception
a. Misrepresentation: misrepresentation of MNOI
b. Omission: must has a pre-existing duty
1) Half truth
2) Statute or regulation requires
2. Materiality
a. Basic test for materiality is whether a reasonable person would attach
importance in determining his choice of action in the transaction.
Texas Gulf
b. An omitted fact is material if there is a substantial likelihood that a
reasonable shareholder would consider that fact important in deciding
how to vote. TSC
c. To fulfill the materiality requirement, there must be a substantial
likelihood that the disclosure of the omitted fact would have ben
viewed by the reasonable investor as having significantly altered the
“total mix” of info made available TSC
d. IN Basic:
1) the materiality= probability*magnitude : Total economic activity:
materiality depends at any given time upon a balancing of both
the indicated probability that the event will occur and the
anticipated magnitude of the event in light of the totality of the
company activity
2) probability: the possibility that it will happen
 3) magnitude: should consider such facts s the size of the two
corporate entities and of the potential premiums over market
value(if your sales are $5 million & you say they’re $6 million,
that is a big lie. But if your sales are $250 million & you say
they’re $251 million that is not so bad)
3. Scienter: what state of mind you need for liability
a. Negligence is not enough
b. Reckless is enough
c. Intentional conduct is enough
4. In connection with sale or purchase of a security
a. Things at issue is security
b. P must have bought or sold the things at issue while the
misrepresentation info. Was on the market
5. Reliance:
a. Traditional theory:
b. Fraud on the market theory(WEST): because most publicly available
information is reflected in market price, an investor’s reliance on any
public material misrepresentation may be presumed for purpose of
10b-5. Public information reaches professional investors, whose
evaluation of that information and trades quickly influence securities
prices
1) Rebutting presumption: D may rebut the fraud on the market
presumption by showing :
a) Invoke truth on market: truth entered into market dissipated
the effects of misstatements
b) Not rely on the purchase: P who believes that public
information is false and P buy or sell stock due to other
reason
6. Causation of damages
a. Transaction causation:
1) But for the misrepresentation or omission, P would not have
come into the transaction
b. Loss causation
1) Was P’s economic loss occasioned by truth revealed followed by
misrepresentation
2) P has duty to prove D’s fraud caused his loss
3) Hypo: ship company made a misstatement about their capacity,
and you buy stock. But ship sinks, and the insurance is not
enough to pay, so the stock down. Your loss is not caused by
misstatement(capacity), but because the insurance(is not
misstatement)

D. Insider trading
1. Did the trader has a duty to speak?
 a. Anyone in possession of material inside information must either
disclose it to public, or if he is disable from disclosing it in order to
protect corporate’s confidence, must abstain from trading in or
recommending the securities concerned while such information
remains undisclosed.(disclose or refrains clause)
2. How long does the duty last?
a. Until the news could reasonably have been expected to appear over
media of widest circulation.
3. Classical theory
a. Definition: Classical insider trading is when a fiduciary (i.e. an
officer or employee of the company) trades in shares of his own firm,
based on information gained as a fiduciary.
b. Rule: If insiders have material non-public information, they must
either disclose the info to the public before trading, OR abstain from
trading.
c. Scope of insider:
1) Officer or employee of a company
2) Constructive insider: under certain circumstances, like
corporation information is revealed legitimately to an
underwriter, accountant, lawyer or consultant working for the
company, these outsiders become fiduciary of SHs, they are
“constructive insiders”
4. Misappropriation theory
a. the defendant did not need to owe a fiduciary duty to the investor
with whom he traded, nor did he need to owe a fiduciary duty to the
issuer of the securities that were traded. Trader breaches fiduciary
duty(duty of trust or confidence) to the source of the information.
b. Duty of trust or confidence(Three situations a person have duty of
trust or confidence):
1) Such duty exists whenever someone agrees to maintain
information in confidence
2) Between two people who have a pattern or practice of sharing
confidences such that the recipient of the information knows or
reasonably should have known that the speaker expects the
recipients to maintain confidence
3) Such duty exists when someone receives or obtains MNPI from a
spouse, parent, child or sibling.
c. Essential deception: deception. So full disclosure forecloses liability
under this theory. b/c if you disclose to source of info that you are
going to trade on NPI, there is no deceptive.
1) Eg. If you call the source of info. you owes fiduciary duty, and
you tell them that you are going to buy stock. But they refuse.
And you go to buy.
 2) You are not liable under misappropriation theory, because you
did not lie, and you disclosed it. There is no deception.
3) But you are liable under state law for breach of fiduciary duty.
d. If trader owes duty of loyalty and confidence to two persons or
entities, he should disclose to both of them. Disclosure to one of them
will be liable.
5. Tipper-tippee theory(applicable to classical and MIS theory)
a. Inherit duty Dirks
1) The insider improperly(breach of fiduciary duty) disclosed the
info to the tippee in echange for personal benefits
2) The tippee knows or sho
3) uld have known that the insider’s breach of duty
b. Tipper can be liable for breach of duty by making a gift of
confidential information to a ‘a trading relative”. But the relation
should be extremely closed relationship. Salmon
c. Tipper can be liable if he discloses to someone who is likely to trade,
in exchange for personal benefits?? 即使 tippee 不知道？
d.
6. How to decide Inherit duty
7. Flowchart of insider trading
a. Classical theory
1) Did trader owe duty to trading partner?
2) If not, did he inherit duty?
b. Misappropriation theory
1) Did trader owe duty to source of info?
2) If not, did he inherit the duty(trust or confidence)?
8. 14 e-3: The rule prohibition covers only one context. It is applied only if
trader knows about the forthcoming transaction. It prohibits insiders of
the bidder and target from divulging confidential information about a
tender offer to persons that are likely to violate the rule by trading on the
basis of that information.
a. If any person has taken a substantial steps to commence, or has
commenced a tender offer
b. The trader must know or have reason to know that the information is
nonpublic
c. The trader also must know or have reason to know the information
was acquired from the employees of offeror or offeree agents.
d. The MNPI regarding the tender offer has not been publicly disclosed
by offeror.
E. Short-swing profits(Security Exchange Act of 1934 Section 16b)
1. Definition of insider
a. Directors, officers,
 1) Officers: Anyone with title of “president, CEO,CFO…”; 2.
Anyone who performs functions that correspond to the functions
typically performed by named persons in other corporation
b. Beneficiary owners: the owner of more than 10% of any class of any
equity security of company
2. Company covered: registered under 1934 Securities Act
a. Listed in national stock exchange, have regular report
b. Assets should be more than $10M, and class of any equity security
should be hold by more than 500 SHs
3. How does 16(a) works?
a. Requires insiders to report trade to SEC(file forms)
4. Equity security only
a. Holder of equity security are paid from profits earned by firms
b. Debts are not covered, but if the debt can be convertible to equity
security, it is covered
5. Order irrelevant
a. Could sell high price, buy low price
b. Could buy low price, sell high price
6. disgorgement remedy
a. give back to company
7. enforced to maximize “gains”
a. no require actual profits, even if he got loss
b. start by matching highest sale and lowest buy price
8. when must you have been a statutory insider?
a. Officer or director: hold insider status only before the 1st matching
transaction is enough; Can resign in the middle
b. 10% SH: must hold the status just before purchase or just before sell
9. HYPO:
a. Company has class A 100,000; class B 1000,000; one SH(not officer
or director) has 10K B (1%);
1) 1.1 buy 20 convertible bonds(=1000A) $10K NO(before,
<10%)
2) 2.1 sell 5K B $40 YES: before >10%
3) 3.1 buy 10K B $30 YES
4) 4.1 sell 15 convertible bonds(A) $11K YES
5) 5.1 sell 1K B $35 NO
b. Convertible bonds to A: 1000*20/(2000+100,000)>10%
c. Remedy: there is no matching class A gain; so B gain: (10-5)K *(40-
30)
IV. Problems of Control: SH voting
A. Voting on what matters?
1. Vote to elect directors
2. Vote to remove directors
3. Vote to approve interest director transaction
 4. Vote to approve fundamental corporate changes
a. Any amendments of articles of corporations: like adding exculpating
provisions
b. Merge
c. Sell of all or substantially all assets of corporate
d. Voluntarily dissolution
B. how does voting occurs?
1. Quorum requirement:
2. Few minority SHs vote, most proxy
a. It is illegal to solicit proxy without proxy statement
b. It prohibits fraud
C. How can proxies be used to control corporate?
1. Try to get new board
2. Get SHs vote either to change the bylaws or to recommend things to
board (business judgement belongs to directors, SH can only
recommend policy things)
D. How does proxies get to SHs?
1. Mailing the insurgent’s materials and charge insurgent for the cost; or
a. Corporation is likely to use this method(list is business secret)
2. Give the insurgents the list so that they can mail the SHs
E. Who pays for proxy solicitation ?
1. Corporation can not reimburse unless:
a. The vote is about policy contest, not for personal power struggle
b. The expenditure is reasonable and proper
c. If the expenses is reasonable, it will be born by corporation,
regardless they win or lose
d. Successful insurgents may be reimbursed if SH ratify the payment
F. How are votes counted?
1. Election: Requires plurality of shares present; top votes get election
2. Everything else: Requires Majority of shares present
3. Straight vote and cumulative vote
a. Default rule: straight vote
4. Formula:
a. A=Total shares/(number of directors +1)
b. B=A+1
c. Round up or add 1: