CHAPTER 37 COPORATE GOVERNANCE AND THE SARBANESOXLEY ACT

Shareholders • Own the corporation. • Not agents of the corporation. – Cannot bind the corporation to contracts. • Have right to vote on certain matters. – E. g. , election of directors and fundamental changes in the corporation. © 2010 Pearson Education, Inc. , publishing as Prentice-Hall 2

Shareholder Meetings – Annual meetings must be held at time set by bylaws. • Elect directors, choose auditor, take other actions. – Special shareholders’ meetings may be called by board, holders of at least 10 percent of stock, or others authorized. • Emergency or important issues. © 2010 Pearson Education, Inc. , publishing as Prentice-Hall 3

Shareholder Meetings (continued) • Shareholders must receive advance, written notice of all meetings. – Electronic notice generally allowed. • Shareholders may vote by proxy. – Appoint agent to vote. – Agent’s identity indicated on proxy card. – Proxy generally valid for 11 months. © 2010 Pearson Education, Inc. , publishing as Prentice-Hall 4

Voting Requirements • At least one class of shares of the corporation must have voting rights. • Shareholders of record as of set date allowed to vote. – Record date not more than 70 days before the shareholders’ meeting. • Corporation must prepare and maintain shareholders’ list. – Must be available for inspection. © 2010 Pearson Education, Inc. , publishing as Prentice-Hall 5

Quorum • Required number of shares that must be represented in person or by proxy to hold a shareholders’ meeting. • Once quorum is present, withdrawal of shares has no effect. • The affirmative vote of the majority of the voting shares represented at a shareholders’ meeting constitutes an act of the shareholders for actions other than for the election of directors. © 2010 Pearson Education, Inc. , publishing as Prentice-Hall 6

Voting for Election of Directors • Straight (Noncumulative) Voting – Each shareholder votes the number of shares he or she owns for each of the positions open. – Majority shareholder therefore can choose the board. • Cumulative Voting – Shareholder can accumulate all of his or her votes and vote them all for one or a few candidates. – Gives minority shareholders a better opportunity to elect someone to board. © 2010 Pearson Education, Inc. , publishing as Prentice-Hall 7

Supramajority Voting Requirement Articles of incorporation or bylaws may require more than a majority of shares to constitute a quorum or for votes for mergers, consolidation, or other important matter. © 2010 Pearson Education, Inc. , publishing as Prentice-Hall 8

Voting Agreements • Shareholders agree in advance as to how their shares will be voted. – Voting Trusts. • Legal title to shares held in name of trustee, who votes the shares. – Shareholder Voting Agreements. © 2010 Pearson Education, Inc. , publishing as Prentice-Hall 9

Selling of Shares • Shareholders may enter agreements to prevent unwanted persons from becoming owners. – Right of first refusal – Buy-and-sell agreement • Articles of incorporation may grant preemptive rights to existing shareholders to buy new shares, thereby avoiding dilution of interests. © 2010 Pearson Education, Inc. , publishing as Prentice-Hall 10

Right to Receive Information • Corporation must furnish shareholders with annual financial statement. • Shareholders have absolute right to inspect shareholders’ list, articles, bylaws, minutes of shareholders’ meetings for past 3 years. • Must demonstrate proper purpose to inspect accounting and tax records, minutes from board and committee meetings, shareholders’ meetings beyond 3 years. © 2010 Pearson Education, Inc. , publishing as Prentice-Hall 11

Dividends • Distribution of profits of the corporation to shareholders. • Paid at discretion of board. • Shareholders on record date receive dividends. • May use additional shares of stock as a dividend. – Not a distribution of corporate assets. – Does not increase shareholder’s proportionate ownership. © 2010 Pearson Education, Inc. , publishing as Prentice-Hall 12

Shareholder Derivative Lawsuits • Brought on behalf of corporation against a third party, when corporation failed to sue. • Brought by shareholder who held shares at time of injury, who fairly represents interests of corporation. – Shareholder must first make written demand on corporation to bring a lawsuit. • Court may dismiss if lawsuit not in best interests of corporation. • Any award goes to corporate treasury; corporation pays shareholder’s expenses. © 2010 Pearson Education, Inc. , publishing as Prentice-Hall 13

Piercing the Corporate Veil • If a shareholder dominates corporation and uses it for improper purposes, court can disregard corporate entity, and hold the shareholder personally liable for the corporation’s debts and obligations. – E. g. , thin capitalization; commingling of personal and corporate assets. – Alter ego doctrine. © 2010 Pearson Education, Inc. , publishing as Prentice-Hall 14

Board of Directors • Elected by the shareholders. • Generally compensated for service. • Responsible formulating policy decisions affecting the corporation. • The board may initiate certain actions that require shareholders’ approval by passing resolution. • Have an absolute right of inspection. © 2010 Pearson Education, Inc. , publishing as Prentice-Hall 15

Selecting Directors • Inside Director – A member of the board of directors who is also an officer of the corporation. • Outside Director – A member of the board of directors who is not an officer of the corporation. – Often selected for business expertise. © 2010 Pearson Education, Inc. , publishing as Prentice-Hall 16

Term of Office • The term of a director’s office expires at the next annual shareholders’ meeting following his or her election, unless otherwise specified in articles of incorporation. • Directors instead may be elected to staggered terms of 2 or 3 years. © 2010 Pearson Education, Inc. , publishing as Prentice-Hall 17

Meetings of the Board of Directors • The directors can only act as a board. • They cannot act individually on the corporation’s behalf. • Every director has the right to participate in any meeting of the board of directors. • Each director has one vote. • Directors cannot vote by proxy. • Regular and special meetings are established by bylaws. © 2010 Pearson Education, Inc. , publishing as Prentice-Hall 18

Quorum and Voting Requirement • Simple majority usually constitutes quorum. • Articles and bylaws may increase this number. • If quorum is present, simple majority of quorum approves or disapproves actions. © 2010 Pearson Education, Inc. , publishing as Prentice-Hall 19

Committees of the Board of Directors • Boards can create committees to handle specific duties. • Audit committee of public company has responsibilities imposed by Sarbanes-Oxley Act. – Only outside directors on audit committee. – At least one financial expert. – Audit committee oversees CPAs employed to audit company. – Audit committee yearly assesses internal controls. © 2010 Pearson Education, Inc. , publishing as Prentice-Hall 20

Corporate Officers • Board of directors appoint officers. • Directors delegate management authority to officers. • Most corporations have president, vice president, secretary, and treasurer. • Officer can be removed by board. © 2010 Pearson Education, Inc. , publishing as Prentice-Hall 21

Agency Authority of Officers • Officers and agents of the corporation have such authority as may be provided in the bylaws or as determined by resolution of the board of directors. • Corporation may ratify unauthorized act. – Officers liable for unauthorized actions. © 2010 Pearson Education, Inc. , publishing as Prentice-Hall 22

Fiduciary Responsibilities of Directors and Officers Duty of Obedience Duty of Care Duty of

Duty of Obedience • Duty to act within the authority conferred by statute, articles of incorporation, bylaws, and resolutions adopted by the board of directors. • Directors and officers who either intentionally or negligently act outside their authority are personally liable for any resultant damages to the corporation or its shareholders. © 2010 Pearson Education, Inc. , publishing as Prentice-Hall 24

Duty of Care • Duty to use care and diligence when acting on behalf of the corporation. • A director or officer who breaches this duty of care is personally liable to the corporation and its shareholders for any damages caused by this breach. © 2010 Pearson Education, Inc. , publishing as Prentice-Hall 25

Duty of Care (continued) • Duty is discharged if officer or director acts: 1. In good faith. 2. With the care that an ordinary prudent person in a like position would use under similar circumstances. 3. In a manner he or she reasonably believes to be in the best interests of the corporation. © 2010 Pearson Education, Inc. , publishing as Prentice-Hall 26

Duty of Care (continued) • Violations of this duty of care include acts of negligence and mismanagement, including failure to: – Make a reasonable investigation of a corporate matter. – Attend board meetings on a regular basis. – Properly supervise a subordinate who causes a loss to the corporation. – Keep adequately informed about corporate matters. – Take other actions necessary to discharge duties. © 2010 Pearson Education, Inc. , publishing as Prentice-Hall 27

Business Judgment Rule • Determination of whether duty was met measured at time decision made. – Hindsight not applied. • Not liable for honest mistakes of judgment. © 2010 Pearson Education, Inc. , publishing as Prentice-Hall 28

Duty of Loyalty • Duty not to act adversely to the interests of the corporation, and to subordinate their personal interests to those of the corporation and its shareholders. • Breach of the duty of loyalty usually occurs because of intentional conduct. © 2010 Pearson Education, Inc. , publishing as Prentice-Hall 29

Duty of Loyalty (continued) • Breaches of the duty of loyalty include unauthorized: – Self-dealing – Usurping a corporate opportunity – Competing with the corporation – Making a secret profit that belongs to the corporation © 2010 Pearson Education, Inc. , publishing as Prentice-Hall 30

Sarbanes-Oxley Act • Passed in response to corporate scandals of late 1990 s, early 2000 s. • Goals to improve corporate governance, eliminate conflicts of interest, instill confidence in public companies. © 2010 Pearson Education, Inc. , publishing as Prentice-Hall 31

Sarbanes-Oxley (continued) • CEO and CFO certification of financial reports. • Reimbursement of bonuses and incentive pay if company must restate financial statements due to noncompliance. • Prohibition on personal loans to directors or officers. • Tampering with evidence of fraud a crime. • Those who have committed securities fraud may not serve as officer or director. © 2010 Pearson Education, Inc. , publishing as Prentice-Hall 32