Emory Corporate Governance and Accountability Review

Arbitrage is a form of trading based upon a disparity in the quoted price of equivalent commodities, securities, or bills of exchange.[1] There are four common types of arbitrage. First, time arbitrage involves the purchase of a commodity against the present sale of that commodity for future delivery.[2]Second, space arbitrage is the purchase of a commodity in one market against the sale of that commodity in another market.[3] Third, kind arbitrage consists of the purchase of a security that is convertible into a second security, together with the simultaneous offsetting sale of that second security.[4] Fourth, risk arbitrage involves investing in securities that are subject to disposition.[5] This transaction results in an economic return where the value realized from the disposition is greater than the cost of the investment.[6]

1] Falco v. Donner Foundation, Inc., 208 F.2d 600 (2d Cir. 1953).

[2] Id. at 7.

[3] Id. For example, the purchase of a commodity in New York against the sale of that commodity in London. Id.

[4] Id.

[5] Arnold S. Jacobs, Section 16 of the Securities Exchange Act, § 6:1 (2013). Types of dispositions include exchange offers, cash tender offers, corporate reorganizations, or liquidations. Id.

[6] Id.

The Board of Directors (Board of Governors, Board of Managers) of a corporation is the source of authority for all corporate affairs.[1] In modern times, the board of directors delegates management authority to executive officers of the corporation to manage the day-to-day operations of the corporation while serving as a supervising body.[2]  

The number of directors sitting on the board at a given time is determined by the corporation’s articles of incorporation or its bylaws, subject to amendments.[3] Modern statutes do not require specific qualification for directors, but a corporation may prescribe qualifications in its articles of incorporation or bylaws.[4] Directors are elected at the corporation’s annual shareholders’ meeting[5] and the term expires at the following annual shareholders’ meeting[6] unless the articles of incorporation adopt a staggered term.[7] A director may resign from the board by written notice, or be removed from the board by shareholders in a special meeting or through judicial proceeding.[8] Vacancies on the board of directors may be filled by shareholders or board of directors’ election.[9]

Examples of a public corporation’s oversight responsibilities are stated in the Modern Business Corporation Act.[10]  The board of directors, as a group, can only act in two ways: first, the board of directors can approve a resolution at a meeting;[11] second, the board of directors can act by written consent.[12] The board of directors may create sub-committees in accordance with the corporation’s bylaws and appoint directors to the subcommittees to advise the management.[13] The board of directors may also appoint officers of the corporation in accordance with the bylaws and distribute assignments to manage the corporation.[14]

The board of directors has fiduciary duties to the corporation including the duty of good faith, the duty of loyalty, and the duty of care.[15]

[1] Model Bus. Corp. Act § 8.01(b) (2002).

[2] See Robert W. Hamilton & Richard D. Freer, The Law of Corporations in a Nutshell 80 (6th ed. 2011). 

[3] Model Bus. Corp. Act § 8.03(a)–(b).

[4] Id. § 8.02.

[5] Id. § 8.03(c).

[6] Id. § 8.05(b).

[7] Id. § 8.06.

[8] Id. §§ 8.07(a), 8.08, 8.09(a).

[9] Id. § 8.10(a)(1)–(2) (2002).

[10] Id. § 8.01(c).

[11] Id. § 8.20(a).

[12] Id. § 8.21.

[13] Id. § 8.25(a).

[14] Id. § 8.40(a)–(b).

[15] See id. § 8.40(a).

The business judgment rule is a legal principle that shields directors, officers, and other agents of a corporation from liability for acts or omissions taken in good faith and with due care.[1] The burden of rebutting the application of the business judgment rule rests on the shareholder-plaintiff challenging a business decision.[2] The shareholder-plaintiff must provide evidence that officers or directors of a corporation breached any of their fiduciary duties of good faith, loyalty or due care, in reaching their business decision.[3]

The rule is based on the presumption that officers and directors of a corporation will make business decisions on an informed, good faith basis and in the best interests of the company.[4] The standard justifications for the business judgment rule two-folded: (1) “judges lack competence in making business decisions,” and (2) “the fear of personal liability will cause corporate managers to be more cautious and [as a result] fewer talented people [will be] willing to serve as direction.”[5] 

[1] 18B Am. Jur. 2d Corporations § 1470 (2006).

[2] Cede & Co. v. Technicolor, Inc., 634 A.2d 345, 361 (Del. 1993), modified in other respects, 636 A.2d 956 (Del. 1994).

[3] Id.

[4] Id.

[5] Daniel R. Fischel, The Business Judgment Rule and the Trans Union Case, 40 Bus. Law. 1437, 1439 (1985). 

Channel stuffing is a method of earnings manipulation.[1] It is the practice of encouraging distributers or retailers to take on more inventory than they can sell in the normal course of business.[2] The purpose of channel stuffing is to artificially inflate revenues in a given reporting period.[3] The practice is fraudulent “when it is used . . . to book revenues on the basis of goods shipped but not really sold because the buyer can return them.”[4] For example, a company may stuff the channel by over-shipping to retailers despite low demand, only to have the product returned en masse when the retailer cannot sell the product.[5] In such cases, channel stuffing is illegal.[6] That said, “[c]hannel stuffing is not fraudulent per se.”[7] Courts have identified situations in which there are legitimate reasons for businesses to engage in the practice.[8] For example, a distributor may offer bulk-pricing discounts or provide retailers with extra inventory during holiday seasons.[9] In such cases, channel stuffing is considered a legitimate business practice.[10]

[1] See Greebel v. FTP Software, Inc., 194 F.3d 185, 202 (1st Cir. 1999).

[2] See Id.

[3] See id.

[4] Makor Issues & Rights, Ltd. v. Tellabs Inc., 513 F.3d. 702, 709 (7th Cir. 2008).

[5] Id.

[6] See id.

[7] Garfield v. NDC Health Corp., 466 F.3d 1255, 1261 (11th Cir. 2006).

[8] Greebel, 194 F.3d at 202-03.

[9] See Johnson v. Tellabs, Inc., 262 F. Supp 2d. 937, 950 (N.D. Ill. 2003) (“In the business world, there certainly is nothing inherently wrong with offering incentives to customers to purchase products.”); Aldridge v. A.T. Cross Corp., 284 F.3d 72, 81 (1st Cir. 2002) (“These figures might well be explained by holiday season sales.”).

[10] See Greebel, 194 F.3d at 202-03.

In Citizens United v. Federal Election Comm’n, the Supreme Court held that the First Amendment prohibits the government from restricting political expenditures by corporations.[1]

In Citizens, a non-profit corporation sued the Federal Election Commission for declaratory and injunctive relief because the non-profit feared that it could be subject to civil and criminal penalties for producing and airing a documentary aimed at U.S. Senator Hillary Rodham Clinton, a Democratic candidate in the 2008 Presidential election.[2]

The Court considered whether it was constitutional to prohibit a corporation from using its general treasury to fund electioneering communications.[3] The Court held that such restrictions were unconstitutional because political speech was an essential mechanism of democracy, and as such, corporations should be afforded protection under the First Amendment.[4]

            The decision in Citizens overturned the Supreme Court’s prior holding in .58 U.S. 310, urt'ngat Congress iceic return wherdifference between the purchase price and the value realized from the dispositiMcConnell v. Federal Election Comm’n, in which the Supreme Court upheld limits on electioneering communications.[5] As a result, Citizens prompted the proliferation of super PACs (political action committees), large organizations that solicit campaign contributions and engage in unlimited political spending due to their legal independence from campaigns.[6]

 [1] Citizens United v. Fed. Election Comm'n, 558 U.S. 310, 311(2010).

[2] Id.

[3] Id. Specifically, the Court considered whether the prohibition mandated under section 441(b) of the Bipartisan Campaign Reform Act was constitutional. Id.

[4] See id. at 313.

[5] Id. at 312; see also McConnell v. Fed. Election Comm’n, 540 U.S. 93 (2003).

[6] See Matt Bai, How Much Has Citizens United Changed the Political Game?, N.Y. Times (July 17, 2012)www.nytimes.com/2012/07/22/magazine/how-much-has-citizens-united-changed-the-political-game.html?pagewanted=1&_r=0.

Corporate governance is a term for the method by which corporations are managed, directed, and controlled.[1] The main purpose of corporate governance is to define the corporation’s objectives; the obligations of the corporation’s officers, directors, and shareholders; and the relationships between those players.[2] Objectives provide direction for a corporation’s board and managers when acting on behalf of the company.[3] Corporations are generally created to provide both economic and legal benefits for their shareholders.[4] Therefore, the ultimate goal for most corporations is to maximize profits for the shareholders.[5]

State laws and regulations impose various procedural requirements that affect corporate governance. [6] For example, many jurisdictions require a board of directors and regulate their actions, require certain meetings, regulate voting, and regulate the appointment, conduct, and removal of officers through statute.[7]

[1] Organisation for Economic Co-Operation and Development, 11 (2004)www.oecd.org/daf/ca/corporategovernanceprinciples/31557724.pdf.

[2] See id.

[3] See id.

[4] See Alpert v. 28 William St. Corp., 478 N.Y.S.2d 443, 448 (Sup. Ct. 1983).  

[5] See id.

[6] See CTS Corp. v. Dynamics Corp. of America, 481 U.S. 69, 90 (1987).

[7] See Model Bus. Corp. Act §§ 7.01, 7.20, 8.01, 8.40 (2002).

Corporate stakeholder is a phrase[KU1]  that is[KU2]  coined corresponding to, but distinct from[PH3] , the traditional concept of “corporate stockholders.”[1]Corporate stakeholder, in its most literal sense, means all groups (including stockholders) that have a stake in the decisions and actions of the corporation.[2]  Of the numerous groups of corporate stakeholders that fit this literal definition, R. Edward Freeman and David L. Reed proposed two tiers of further definitions for the term (or phrase) “corporate stakeholder,” according to the extent of the stakes involved in the corporation’s survival:

  • The Wide Sense of Stakeholder: Any identifiable group of individual who can affect the achievement of an organization’s objectives or who is affected by the achievement of an organization’s objectives. (Public interest groups, protest groups, government agencies, trade associations, competitors, unions, as well as employees, customer segments, shareowners, and others are stakeholders, in this sense.)
  • The Narrow Sense of Stakeholder: Any identifiable group or individual on which the organization is dependent for its continued survival. (Employees, customer segments, certain suppliers, key government agencies, shareowners, certain financial institutions, as well as others are all stakeholder in the narrow sense of the term.) [3]

James E. Post, Lee E. Preston, and Sybille Sachs proposed another definition of “corporate stakeholder,” which contends that “[t]he stakeholders in a corporation are the individuals and constituencies that contribute, either voluntarily or involuntarily, to its wealth-creating capacity and activities, and that are therefore its potential beneficiaries and/or risk bearers[PH4] .” [4]

The two definitions are congruent with one exception: Freeman and Reed’s definition includes adversary groups. Their rationale is that “from the standpoint of corporate strategy, stakeholder must be understood in the wide sense: strategies need to account for those groups who can affect the achievement of the firm’s objectives.”[5] Post et al.’s proposed definition however, leaves no room for adversary groups. Their rationale is that “corporations should aim for mutually beneficial (and certainly not harmful) relationships with stakeholders.”[6]

[1] See R. Edward Freeman & David L. Reed, Stockholders and Stakeholders: A New Perspective on Corporate Governance, 25 Cal. Mgmt. Rev. 88, 88 (1983).

[2] See id. at 89.

[3] Id. at 91 (emphasis in original).

[4] James E. Post, Lee E. Preston & Sybille Sachs, Redefining the Corporation: Stakeholder Management and Organizational Wealth 19 (2002).

[5] Freeman & Reed, supra note 1, at 91.  

[6] Post et al., supra note 4, at 19.


 [KU1]Would it be better to refer to Corporate Stakeholder as a “term” rather than a “phrase”?  This is more of a style issue.

 [KU2]Did you mean to say “was”?

 [PH3]Added commas to separate phrase.

 [PH4]I suggest a paraphrasing of this quote along the lines of: potential beneficiaries and/or risk bears who contribute, voluntarily or involuntarily, to a corporations wealth creation. This will also help to eliminate excess words.

corporation is a formal business association that exists as a distinct legal entity.[1]

Corporations must be formally established through Articles of Incorporation.[2]  Articles of Incorporation must include a corporate name with a suffix signaling limited liability, such as “Ltd.,” “Corp.,” or “Co.”[3] Articles of Incorporation must also include the number of authorized shares, or the maximum amount of shares that the corporation may issue.[4] Finally, the Articles of Incorporation must include the address of an initial registered agent, as well as the name and address of the person incorporating the business.[5]

A key feature of corporations is limited liability of the shareholders or owners of the corporation.[6] The maximum liability to shareholders or owners resulting from the business would not typically exceed their investment in the business.[7]

Corporations could be public or closely-held. Ownership in a public corporation is transferrable through a primary market, in which the corporation sells its own shares.[8] For a closely held corporation, shares are not generally traded on a securities exchange, nor are they readily transferrable.[9]

[1] James D. Cox & Thomas Lee Hazen, Treatise on the Law of Corporations §1:2 (2012).

[2] Id., at § 3:4.

[3] Id.

[4] Id.

[5] Id.

[6] Id., at § 1:2.

[7] Id.

[8] Id., at § 1:20.

[9] Id., at § 14:1.

In a derivative action, a shareholder brings a lawsuit on behalf of a corporation to enforce a claim.[1] The shareholder must represent the best interests of similarly situated shareholders or members.[2] Additionally, the shareholder must state in his pleading any demand made upon the board of directors to “obtain the desired action”[3] and “the reasons for not obtaining the action or not making the effort.”[4] However, this rule may be excused if the shareholder shows that demand would have been futile.[5]

There are two factors for determining demand futility: (1) whether there is reasonable doubt that the directors are “disinterested and independent” and (2) whether there is reasonable doubt that “the challenged transaction was otherwise the product of a valid exercise of business judgment.”[6] Only a finding of one of the factors is needed for demand to be excused.[7]

A director’s interest means that he “stands to gain or lose personally and materially depending on the board’s decision.”[8] “Independence means that a director’s decision is based on the corporate merits of the subject before the board rather than extraneous considerations or influences.”[9]

[1] Fed. R. Civ. P. 23.1(a).

[2] Id.

[3] Fed. R. Civ. P. 23.1(b)(3)(A).

[4] Fed. R. Civ. P. 23.1(b)(3)(B).

[5] Jerue v. Millett, 66 P.3d 736, 743 (Alaska 2003).

[6] Aronson v. Lewis, 473 A.2d 805, 814 (Del. 1984).

[7] Brehm v. Eisner, 746 A.2d 244, 256 (Del. 2000).

[8] Sonus Networks, Inc. v. Ahmed, 499 F.3d 47, 67 (1st Cir. 2007).

[9] Aronson, 473 A.2d at 816.

A shareholder derivative suit, or derivative action, is a lawsuit brought by a shareholder on behalf of a corporation.[1] “[T]he . . . object of the derivative suit mechanism is to permit shareholders to file suit on behalf of a corporation when the managers or directors of the corporation, perhaps due to a conflict of interest, are unable or unwilling to do so, despite it being in the best interests of the corporation.”[2] To bring a derivative suit, the complaint must allege “the plaintiff was a shareholder or member at the time of the transaction complained of, or that the plaintiff’s share or membership later devolved on it by operation of law.”[3] In most states, the derivative plaintiff must demonstrate that she will adequately represent the interests of the corporation.”[4] In many states, statutes also require that shareholders make a written demand of the board for the corporation to vindicate its claim.[5] If the board accepts the demand, the corporation will proceed on its own behalf. If the board rejects the demand, the shareholders may proceed with the derivative action.[6]

[1] David G. Epstein, Richard D. Freer, Michael J. Roberts & George B. Shepherd, Business Structures 271 (3d ed. 2010).

[2] First Hartford Corp. Pension Plan & Trust v. United States, 194 F.3d 1279, 1295 (Fed. Cir. 1999).

[3] Fed. R. Civ. P. 23.1(b)(1).

[4] Robert W. Hamilton & Richard D. Freer. The Law of Corporations in a Nutshell 358 (6th ed. 2011).

[5] Id. at 359 ̶60.

[6] Epstein at 278.

Derivatives are financial commodities, in the form of a contract, that derive value from another source.[1]  Examples of the types of sources that can be used to value derivatives are foreign currencies, interest rates, and treasury bonds.[2]  Derivatives are often speculative in nature.[3]

Some derivatives can be sold in over-the-counter swaps, meaning that they are not sold on a national exchange and are not registered with a regulatory agency.[4]  However, with the introduction of the Dodd-Frank Wall Street Reform and Consumer Protection Act, some previously unregulated derivative trades must now go through exchanges or clearinghouses prior to being sold.[5]  Decisions over how to regulate derivative markets are handled by the Commodity Futures Trading Commission and the Securities and Exchange Commission.[6]

[1] Black’s Law Dictionary 509 (9th ed. 2009).

[2] Id.

[3] Procter & Gamble Co. v. Bankers Trust Co., 925 F. Supp. 1270, 1275 (S.D. Ohio 1996).

[4] Id. at 1279.

[5] Mark D. Sherrill, Are There Futures In Your Futures? A Primer on Bankruptcy, Cleared Swaps and Futurization, 32 Am. Bankr. Inst. L. Rev. 16 (2013).

[6] Id.

The Dodd-Frank Wall Street Reform and Consumer Protection Act, enacted on July 21, 2010, is a United States federal law which, among other purposes, aims “to promote the financial stability of the United States by improving accountability and transparency in the financial system, to end 'too big to fail' [phenomenon in the banking system], [and] to protect consumers from abusive financial services practices.”[1]  

The Act attempts to achieve its purpose through several means: First, the Act created the Financial Stability Oversight Council to monitor financial institutions and to respond to any potential risks to the U.S. economy.[2] Second, the Act created parallel regulatory regimes for the U.S. Commodity Futures Trading Commission and the Securities Exchange Commission to regulate the swaps market.[3]  Third, the Act enacted a requirement for large financial institutions to retain more of the credit risks of securitizations, where they consolidate debt to sell to investors.[4]  Fourth, the Securities and Exchange Commission will work to protect and promote investors by holding Credit Rating Agencies liable for abuse.[5]  Fifth, the Act incorporated The Volcker Rule to regulate proprietary trading and investments.[6]  Finally, the Act reformed the regulation of mortgage lending to ensure fair and safe consumer lending practices.[7]

[1] Dodd-Frank Wall Street Reform and Consumer Protection Act, H.R. 4173, 111th Cong. (2010).  .

[2] The Dodd-Frank Act: A Cheat Sheet 4, Morrison & Foerster, LLP (2010),www.mofo.com/files/uploads/images/summarydoddfrankact.pdf (last visited October 19, 2013).

[3] Id. at 11.

[4] Id. at 8.

[5] See id. at 16.

[6] See Brief Summary of the Dodd-Frank Wall Street Reform and Consumer Protection Act 12, U.S. Sen. Committee on Banking, Housing, and Urban Affairswww.banking.senate.gov/public/_files/070110_Dodd_Frank_Wall_Street_Reform_comprehensive_summary_Final.pdf(last visited October 19, 2013).

[7] See id. at 9.

Equity is a financial interest an owner has in a company.[1] This financial interest can be referred to by different names, including shareholders’ equity for corporations.[2] An equity owner holds a share that is “[o]ne of [a] definite number of equal parts into which the capital stock of a corporation . . . isdivided.”[3] Equity can be calculated as the difference in value between the company’s total assets and its total liabilities.[4] When a company’s liabilities exceed its assets, it may be characterized as having zero equity,[5] being insolvent,[6] or both.

[1] Black’s Law Dictionary 619 (9th ed. 2009)

[2] Id., at 1215. 

[3] Id., at 1500. 

[4] In re Lifschultz Fast Freight, 132 F.3d 339, 350 (7th Cir. 1997). 

[5] Id.

[6] 11 U.S.C. § 101(32) (2012).

The False Claims Act (“FCA”) imposes liability on any person who knowingly makes or uses a false statement which causes the government or a governmental program to make payment on or approve a false or fraudulent claim.[1] In an FCA case, the government may file suit directly or a private person may file suit on the government’s behalf.[2] If a private person files an FCA claim, that person is referred to as a qui tam relator and may recover damages on the government’s behalf.[3] Since 1986, the FCA has been repeatedly amended to make it more plaintiff-friendly.[4]

[1] Allison Engine Co., Inc. v. U.S. ex rel. Sanders, 553 U.S. 662 (2008); see also 31 U.S.C. § 3729.

[2] 31 U.S.C. § 3730(b).

[3] Timson v. Sampson, 518 F.3d 870, 872 (11th Cir. 2008).

[4] See Michael Volkov,The Six Most Significant Recent Amendments to the False Claims Act, JDSupra.com (July 23, 2012)www.jdsupra.com/legalnews/the-six-most-significant-recent-amendmen-50390/.

Fiduciary duty is the “duty of utmost good faith, trust, confidence, and candor owed by a fiduciary (such as a lawyer or corporate officer) to the beneficiary (such as a lawyer’s client or a shareholder).”[1] Fiduciary duty also includes “a duty to act with the highest degree of honesty and loyalty toward another person and in the best interests of the other person (such as the duty that one partner owes to another).”[2] Judge Benjamin Cardozo described the scope of the duties that one partner owes to another partner as “the duty of finest loyalty . . . Not honesty alone, but the punctilio of an honor the most sensitive, is then the standard of behavior.”[3]

Fiduciary duties owed by corporate officers and directors to their corporations fall into two general categories: (1) the duty of care, and (2) the duty of loyalty.[4] In cases where action by directors leads to loss for the corporation, courts have developed the “business judgment rule” to assess whether those corporate officers and directors have breached their duty of good faith[KU1] .[5]

As part of the duty of care, directors are expected to monitor the performance of the company’s CEO as well as other senior managers assigned with the daily management of the company.[6] The duty of loyalty can be best understood as “a person’s duty to not engage in self-dealing or otherwise use his or her positions to further personal interests rather than those of the beneficiary.”[7]

The scope of fiduciary duties is broader in partnerships than it is in the context of corporations.[8] Fiduciary duties of partners may not be waived in or eliminated by partnership agreements.[9]  

[1] Black’s Law Dictionary 581 (9th ed. 2009).

[2] Id.

[3] Meinhard v. Salmon, 164 N.E. 545, 546 (N.Y.1928).

[4] Joseph Shade, Business Associations in a Nutshell 185 (3d ed. 2010).

[5] Id.  Compare Shlensky v. Wrigley, 237 N.E.2d 776, 781 (Ill. App. 1968) (holding that in the absence of a clear showing of dereliction of duty by directors, the court will not require directors to forgo their business judgment), with Smith v. Van Gorkom, 488 A.2d 858, 872 (Del. 1985) (holding that under the business judgment rule there is no protection for directors who exercise unintelligent or unadvised judgment).

[6] Shade, supra note 3, at 193.

[7] Black’s Law Dictionary 581 (9th ed. 2009).

[8] Shade, supra note 3, at 231.

[9]See Revised Unif. P’ship Act § 103 (2013-2014).  However, partnership agreements may provide standards that can be used to define the scope of and how to evaluate partners’ performance of their fiduciary duties.  SeeRevised Unif. P’ship Act § 103 cmt. 4 (2013-2014 ).

The Foreign Corrupt Practices Act of 1977 (“FCPA”) has two primary functions.[1] First, the FCPA discourages corporate bribery by prohibiting certain classes of persons and entities from making payments to foreign government officials in order to obtain an unfair advantage.[2] However, the FCPA does not prohibit payments made to foreign officials if they are meant to expedite or ensure the performance of a “routine governmental action.”[3]

Second, the FCPA imposes certain accounting and filing requirements on companies with securities listed in the United States.[4] These provisions require a covered party to make and keep records that accurately and fairly reflect its transactions. Additionally, they require these parties to devise and maintain a sufficient system of internal accounting controls.[5] A party violates these provisions if it knowingly circumvents or fails to implement a system of internal accounting controls or knowingly falsifies records.[6]

[1] See 15 U.S.C. § 78dd-1, et seq.

[2] Foreign Corrupt Practices Act, An Overview Department of Justice,www.justice.gov/criminal/fraud/fcpa/ (last visited Jan. 1, 2014). The FCPA covers persons and entities that include U.S. citizens, nationals, residents, or any foreign businesses that have their principal place of business in the United States. Id.

[3] See 15 U.S.C. §§ 78dd-1(b), 78dd-2(b) (2013). See also S.R. Rep. No. 95-114, at 10 (1977), reprinted in 1977 U.S.C.C.A.N. 4098, 4108.

[4] See 15 U.S.C. § 78m.

[5] See 15 U.S.C. § 78m(b)(2).

[6] See 15 U.S.C. § 78m(b)(4)-(5).

Form 10-K discloses basic information about a publicly traded company’s performance.[1] It is a mandatory annual filing with the U.S. Securities and Exchange Commission.[2] A Form 10-K addresses all aspects of a company’s financial condition.[3] The primary disclosures concern the company’s financial statements, which include a company’s balance sheet, income statement, and statement of cash flows.[4] This data is supplemented with qualitative insights that include recent financial developments, risk factors, tangible assets, executive compensation, and pending legal proceedings.[5]

[1] Form 10-K, U.S. Securities and Exchange Commission (June 26, 2009) www.sec.gov/answers/form10k.htm.

[2] Id.

[3] See id.

[4] See id.

[5] Id.

The SEC mandates that issuers of securities registered on the national securities exchange file certain information and reports.[1] Included in these filings are quarterly reports on Form 10-Q that disclose corporate developments.[2] Form 10-Q has nearly the same reporting requirements as annual reports, but a key difference between the two is that the financial results in Form 10-Q are unaudited.[3] Although the financial results are unaudited, the act enabling the Form 10-Q  “embodies the requirement that such reports be true and correct[] and a failure to comply with such [requirement] would result in violations of the securities laws.”[4]

Form 10-Q must be filed for each of the first three fiscal quarters of a company's fiscal year and should include a company’s unaudited financial statements. [5] Form 10-Q should also provide a continuing view of the company's financial position during the year.[6] Smaller companies may be subject to different reporting requirements than larger companies.[7]Additionally, companies that have less than $75 million in public equity float will qualify for reduced disclosure requirements.[8]

[1] 15 U.S.C. § 78m(a) (2012).

[2] Id. See SEC v. World-Wide Coin Inv., 567 F. Supp. 724, 759 (N.D. Ga. 1983).

[3] Freeport-McMoran Sulphur, LLC v. Mike Mullen Energy Equip. Res., Inc., No. Civ.A. 03-1664, 2004 U.S. Dist. LEXIS 10197, at *6 (E.D. La. June 3, 2004).

[4] SEC v. Kalvex, Inc., 425 F. Supp. 310, 316 (S.D.N.Y. 1975) (citing duPont v. Wyly, 61 F.R.D. 615, 632 (D. Del. 1973)).

[5] Form 10-Q, www.sec.gov/answers/form10q.htm (last visited Sept. 18, 2013).

[6] Id.

[7] See 17 C.F.R. § 230.405 (2013).

[8] Id.

Generally Accepted Accounting Principles (GAAP) is a series of general principles followed by accountants in preparation of financial statements.[1]GAAP “encompasses all of the changing conventions, rules, and procedures that define accepted accounting practices at a particular point in time . . . .”[2]Although not always mandatory, GAAP should be followed by all entities in order to provide transparency[3] in accounting of financial statements. GAAP became particularly important after the SARBANES–OXLEY ACT OF 2002,[4]which was signed in response to the Enron collapse.[5]

GAAP for non-governmental entities is developed by the Financial Accounting Standards Board,[6] which codified GAAP in the Accounting Standards Codification.[7] The Federal Accounting Standards Advisory Board sets forth the GAAP principles for federal entities in the FASAB Handbook.[8] GAAP for state and local government is established by the Governmental Accounting Standards Board.[9]

[1] U.S. v. Basin Elec. Power Coop., 248 F.3d 781, 786 ( 8th Cir. 2001).

[2] Shalala v. Guernsey Mem’l Hosp., 514 U.S. 87, 101 (1996).

[3] Robert K. Herdman,  Chief Accountant, U.S. Sec. &  Exch. Comm’n, Testimony before H. Comm. of Capital Markets and Government Sponsored Enterprises, 107th Cong. (2002), available atwww.sec.gov/news/testimony/051402tsrkh.htm, (explaining that accounting has to be transparent in order to allow investors and other market entities to make “informed investment decisions through full and fair disclosure”).

[4] Glen M. Vogel, Stuart L. Bass, & Nathan S. Slavin, The Scienter Roadblock has Prevented Litigants From Advancing Down the Sarbanes-Oxley Litigation Highway, 40 Sec. Reg. L.J.(2012) (discussing the fall of Enron and the subsequent accounting scandal, which “rocked the financial world”) 

[5]Id.

[6] See Fin. Accounting Standards Bd., Accounting Standards Codification 4, (Dec. 11, 2012), https://asc.fasb.org/imageRoot/80/34350180.pdf .

[7] Id.

[8] Fed. Accounting Standards Advising Bd., Our Mission,  F.A.S.A.B., (last visited Sept. 17, 2013)  www.fasab.gov/about/mission-objectives/(stating their mission as supporting public accountability. “[F]inancial reports, which include financial statements prepared in conformity with generally accepted accounting principles, are essential for public accountability and for an efficient and effective functioning of our democratic system of government.” “[T]hus, the Board plays a major role in fulfilling the government’s responsibility to be publicly accountable.” “[F]ederal financial reports should be useful in assessing (1) the government’s accountability and its efficiency and effectiveness, and (2) the economic, political, and social consequences, whether positive or negative, of the allocation and various uses of federal resources.”).

[9] Gov’t Accounting Standards Bd., Mission, Vision, and Core Values, G.A.S.B., (last visited Sept. 17, 2013)www.gasb.org/jsp/GASB/Page/GASBSectionPage&cid=1175804850352(stating that the goal of the F.A.S.B. is to provide “[g]reater accountability and well-informed decision making through excellence in public-sector financial reporting”).

The Glass-Steagall Act (“GSA”) commonly refers to Sections 16, 20, 21, and 32 of the Banking Act of 1933.[1] In passing the GSA, Congress hoped to “restore public confidence in the banking industry, ensure and maintain economic stability by prohibiting unsound and imprudent banking conditions, and remove potential conflicts of interest.”[2] Congress has created a distinction between commercial banking and investment banking through Sections 16 and 21 of the GSA legislation.[3] Section 20 bars Federal Reserve System member banks from affiliating with any organization “engaged principally” in the investment banking business.[4]  Section 32 aims to prevent “management interlocks”[5] between commercial banks and those engaged principally in investment banking activities by barring investment bank directors, officers, employees, and principals from holding the same position or duties at a Federal Reserve System member bank.[6] 

While Sections 16 and 21 seemingly erect a wall between commercial and investment banking, the GSA does not create an impenetrable barrier between these two activities.[7] In fact, the GSA permitted commercial banks to:

(i) buy and sell securities on the order of, and for the account of, their customers, (ii) underwrite obligations of the United States and the general obligations of states and political subdivisions thereof, (iii) purchase for their own accounts investment securities under regulations of the Comptroller of the Currency, and (iv) otherwise to act in accordance with their traditionally permitted trust powers.[8]

In 1999, the Gramm-Leach-Bliley Act (“GLBA”) was passed and repealed GSA.[9] The GLBA removed restrictions on underwriting by commercial banks and altogether repealed GSA Section 20, thereby permitting commercial banks to take part in investment banking activities through the creation of financial holding companies and subsidiaries.[10] It also repealed the GSA Section 32 prohibition of management interlocks between commercial and investment banks.[11]

[1] See Nikolas Theodore Nikas, Banking Law – Commercial Paper is a Security Under the Glass-Steagall Act – Securities Industry Association v. Board of Governors of the Federal Reserve System, 104 S. Ct. 2979 (1984), 1985 Ariz. St. L.J. 799, 799 n. 2..

[2]  Id. at 801.

[3] See id. at 802-03.

[4] See id. at 802 n. 13.

[5] See Ehud Ofer, Glass-Steagall: The American Nightmare That Became the Israeli Dream, 9 Fordham J. Corp. & Fin. L. 527, 544 (2004).

[6] See Jonathan Zubrow Cohen, The Mellon Bank Order: An Unjustifiable Expansion of Banking Powers, 8 Admin. L.J. Am. U. 335, 344 (1994).

[7] See Joseph Jude Norton, Up Against “The Wall”: Glass-Steagall and the Dilemma of a Deregulated (“Regulated”) Banking Environment, 42 Bus. Law. 327, 327 (1987).

[8] Id. at 327-28.

[9] See Jerry W. Markham, The Subprime Crisis – A Test Match for the Bankers: Glass-Steagall vs. Gramm-Leach-Bliley, 12 U. Pa. J. Bus. L. 1081, 1103 (2010).

[10]  See id. at 1103-04.

[11]  See supra note 5.

The term “hedge fund” generally refers to a private investment pool that is organized and operated to be exempt from the registration and regulatory requirements of the Securities Exchange Act of 1933 and the Investment Company Act of 1940.[1] Structured as private limited partnerships, limited liability companies, or business trusts,[2] hedge funds are managed by investment advisers who have a significant financial stake in their fund[3] and are compensated by management fees based on the performance of their fund.[4] To avoid registration and regulatory requirements, a hedge fund may not have more than 100 investors and must restrict its offerings to only highly sophisticated investors.[5] Further, a hedge fund may not offer its securities publicly or engage in public solicitation.[6]

The investment goals of hedge funds vary among funds, but many seek to limit risk and volatility while achieving an absolute positive return for investors.[7]Hedge funds originally used hedging as an investment strategy.[8][TM1]  Hedging involves the purchasing of a security and then taking an offsetting position in a related security so as to reduce the overall risk of loss on the investment as a whole.[9] While hedging is still an essential component of hedge funds, hedge funds now use a variety of strategies including arbitrage, leverage, short-selling, and the purchasing of complex derivatives.[10] “Hedge funds invest in equity and fixed income securities, currencies, over-the-counter derivatives, futures contracts, and other assets.”[11]

[1] See U.S. Sec. & Exchange Comm’n, Staff Report, Implications of the Growth of Hedge Funds, at viii (2003), available atwww.sec.gov/news/studies/hedgefunds0903.pdf.

[2] Id. at 9.

[3] Id. at viii, ix.

[4] See id. at ix.

[5] See id.

[6] See id. at x.

[7] Id. at viii.

[8] See Jacob Preiserowicz, The New Regulatory Regime for Hedge Funds: Has the SEC Gone Down the Wrong Path?, 11 Fordham J. Corp. & Fin. L. 807, 809 (2006).

[9] Id.

[10] Id. at 809-10.

[11] U.S. Sec. & Exchange Comm’n, Staff Report, supra note 1.

The transition from a closely held corporation to a publicly held corporation is termed an initial public offering[1]

Closely held corporations choose to have initial public offerings for many reasons.[2]  One reason that an initial public offering may be attractive to corporations is that it serves as a method of generating capital.[3]  Other reasons that corporations choose to go public include  increased prestige,[4]transferability of the corporation’s shares,[5] and publicity.[6]

Three groups regulate initial public offerings.[7]  The Securities Exchange Commission regulates initial public offerings through its Securities Act of 1933 and Securities Exchange Act of 1934.[8]  The Securities Act of 1933 governs “fraud, registration, and disclosure.”[9]  On the other hand, the Securities Exchange Act of 1934 regulates practices that manipulate the prices of shares on the market.[10]  The stock exchange that the corporation goes public on will have a variety of listing requirements by which the corporation will have to abide.[11]  Finally, the National Association of Securities Dealers governs the conduct of the underwriters that take part in the initial public offering process.[12]

One particularly difficult issue that concerns all parties involved in public offerings is pricing.[13]  In the context of the initial public offering, stocks are generally underpriced.[14]  Some authors opine that corporations are worried about failed public offerings to such an extent that they keep the prices low in order to ensure success.[15]  Others find this theory of underpricing dubious.[16]

[1] Christine Hurt, Moral Hazard and the Initial Public Offering, 25 Cardozo L. Rev. 711, 712 (2004); see James D. Cox & Thomas Lee Hazen, Corporations 23 (2d ed. 2003).  Closely held corporations are defined as “a corporation[s] with relatively few shareholders,” and “corporation[s] whose shares are not generally traded in securities markets.” Id. Publicly held corporations are “business corporation[s] . . . which have numerous shareholders . . . and whose shares (or some classes of shares) are traded on a national securities exchange or at least are traded regularly in the over-the-counter market maintained by securities dealers.” Id.

[2] See id. at 718.

[3] Jay R. Ritter & Ivo Welch, A Review of IPO Activity, Pricing, and Allocations, 57 J. Fin. 1795, 1796 (2002). To explain the benefits of this method, Ritter and Welch highlight various theories; all of these theories share the idea that the company can raise greater amounts of capital in comparison to what it would raise as a closely held corporation via an initial public offering.  Id. at 1798.

[4] Hurt, supra note 3, at 718.

[5] Id.

[6] Ritter et al., supra note 5, at 1796.

[7] Hurt, supra note 3, at 732.

[8] James D. Cox & Thomas Lee Hazen, The Law of Securities Regulation 255 (6th ed. 2009).

[9] Id.

[10] Id.

[11] Hurt, supra note 3, at 732.

[12] Id.

[13] Cox et al., supra note 10, at 262-63. This presents a difficult situation. On one hand, if one overprices and the stock price falls, investors may claim that they were mislead into purchasing the stock.  Id.  On the other hand, if the stock is underpriced, shareholders may claim that the corporation’s executives breached their duty to obtain as high a price for the shares as possible.  Id.

EME NOTE: (1) ) If it’s in the footnotes, it’s discussed in the text. (2) Please, no Greek mythology. Thank you.

[14] Id.

[15] Id.

[16] See Hurt, supra note 3, at 724-25 (indicating that underpricing is part of a scheme which simultaneously works illegally to the detriment of retail investors and the benefit of underwriters and market analysts).

Insider trading involves the purchase or sale of securities on the basis of material, non-public information, and is illegal in a variety of circumstances.[1]Congress addressed the appropriateness of insider trading in §§ 10(b) and 16(b) of the Securities Exchange Act of 1934.[2] Section 10(b) of the 1934 Act makes it unlawful for any person “to use or employ, in connection with the purchase or sale of any security . . . any manipulative or deceptive device or contrivance in contravention of such rules and regulations as the [SEC] may prescribe.”[3] To implement § 10(b), the SEC adopted Rule 10b-5, which broadly prohibits fraud in connection with the purchase or sale of any security.[4]

Under the traditional theory of insider trading, § 10(b) and Rule 10b-5 are violated when a corporate insider buys or sells a security in violation of a direct duty to that company and its shareholders.[5] Trading on such information qualifies as a deceptive device under § 10(b) because a relationship of trust and confidence exists between the shareholders of a corporation and those insiders who have obtained confidential information by reason of their position with that corporation.[6] Under the “misappropriation theory” of insider trading, § 10(b) and Rule 10b-5 are violated when a corporate outsider misappropriates confidential information in breach of a duty owed to the source of the information.[7] In either case, the individual must abstain from trading in the shares of the corporation unless the individual has first disclosed all material, nonpublic information to the party whom he or she owes a duty.[8]

Section 16(b) of the 1934 Act requires company insiders to return profits made on short-swing transactions that occur within any six-month period.[9] This rule prevents company insiders from taking unfair advantage of information obtained as a result of their relationship with an issuer.[10]

[1] Black's Law Dictionary 866 (9th ed. 2009).

[2] See Securities Exchange Act of 1934, 15 U.S.C. § 78 (2012).

[3] 15 U.S.C. § 78j(b).

[4] See 17 C.F.R. § 240.10b–5 (2011).

[5] See Chiarella v. United States, 445 U.S. 222, 228 (1980).

[6] Id.

[7] United States v. O'Hagan, 521 U.S. 642, 652 (1997).

[8] Cady, Roberts & Co., 40 S.E.C. 907, 912-13 (1961); see also SEC v. Texas Gulf Sulphur Co., 401 F.2d 833 (2d Cir. 1968).

[9] 15 U.S.C. § 78p(b).

[10] Id.

Limited Liability Company (LLC) is a non-corporate business entity governed by state law.[1]

The LLC is a combination of two traditional business structures, a corporation and a partnership.[2] However, the LLC offers certain advantages over each of these structures. One of the LLC’s primary advantages is that it is taxed as a partnership for federal tax purposes.[3] However, unlike a partnership, an LLC offers a corporate shield to protect its members’ and managers’ personal assets from creditors.[4] Further, unlike a corporation, an LLC is not double taxed because earnings and losses pass through the LLC to its members.[5]

LLCs are not without disadvantage. Members of LLCs are subject to self-employment taxes.[6] Additionally, LLC statutes lack comprehensive default rules.[7] States differ regarding the regulations they use to govern LLCs. Some states have adopted a uniform act,[8] while the majority of states have chosen to create their own individual regulations.[9]

[1] Taxation of Limited Liability Companies, I.R.S. Pub. 3402, 2 (Mar. 2010) (explaining how LLCs are taxed).

[2] See Howard M. Freidman, The Silent LLC Revolution—The Social Cost of Academic Neglect, 38 Creighton L. Rev. 35, 40-42 (2004-2005).

[3] I.R.S. supra note 1, at 2.

[4] Friedman, supra note 2, at 49.

[5] Id. at 49-50 (explaining double taxation as (1) corporations are taxed on their earnings, and (2) corporate shareholders are taxed on any after-tax earnings that pass through to them as dividends); I.R.C. § 11 (West 2006) (taxes paid on earnings).

[6] Id. at 53.

[7] See id. at 55.

[8] Legislative Fact Sheet – Limited Liability Company (Revised), Uniform Law Commission (2013) www.uniformlaws.org/LegislativeFactSheet.aspx (at least 10 states have adopted the uniform act).

[9] See id. (most states have not adopted the uniform act).

Market capitalization is an organization’s current share price multiplied by the number of shares outstanding.”[1]  “When expressed as a ratio to earnings, the resulting number is the firm’s price/earnings ratio or (P/E) multiple."[2]Under the Commodity Exchange Act, market capitalization of a security is determined by taking the average of the daily market capitalizations for the preceding six months.[3] 

Market capitalization is used as a basic method of valuation, anchored in the company’s actual performance.[4] Investors use market capitalization to divide the stock market into different categories according to market capitalization on an annual basis.[5] 

[1] Thomas P. Fitch, Dictionary of Banking Terms 282 (Irwin Kellner & Donald G. Simonson eds., 4th ed. 2000)

[2] Id.

[3] 17 C.F.R. § 41.11(a) (1) (clarifying Commodity Exchange Act, 7 U.S.C. § 1a(35)(B), 49 Stat. 1491 (2012)).

[4] VFB LLC v. Campbell Soup Co., 482 F.3d 624, 631 (3d Cir. 2007)

[5] See e.g., Russell U.S. Equity Indexes Construction and Methodology 3, Russell Investments, www.russell.com/indexes/documents/Methodology.pdf(last visited Sept. 20, 2013).

mutual fund is a jointly-owned financial instrument used for investing in stocks, bonds, money-market instruments, and other securities.[1] Since the Great Depression, mutual funds have become critical to the American financial system and are the investment tool of choice for many in our economic system.[2] Mutual funds, being open-ended funds, give the shareholders the compulsory ability to redeem their shares.[3]

There are several elements that distinguish a mutual fund from other intermediary investment mechanisms.[4] Investors pool their money to create an investment company. [5] This investment company then offers the investors shares that represent undivided ownership interest in the pool.[6] The management of the mutual fund, which is separate from its investors, invests and reinvests the pooled funds in securities.[7] The equal division of the net assets of the pool determines the value of each share.[8]

[1]  Invest Wisely: Mutual Funds, http://www.sec.gov/investor/pubs/inwmf.htm(last visited Oct. 9, 2013).

[2]  Invest Wisely: Mutual Funds, supra note 1.

[3]  United States v. Cartwright, 411 U.S. 546, 547 (1973).

[4]  Invest Wisely: Mutual Funds, supra note 1.

[5]  United States v. National Ass’n of Sec. Dealers, Inc., 422 U.S. 694, 698 (1975).

[6]  Lois Yurow ET AL., Mutual Fund Regulation and Compliance Handbook § 4:1 (west 2013).

[7] National Ass’n of Sec. Dealers, Inc., 422 U.S. at 699.

[8] Id. at 699.

A partnership is an “association of two or more persons to carry on as co-owners a business for profit . . . whether or not the persons intend to form a partnership.”[1] Thus, a business is a partnership if it has more than one owner and is formed without any action taken “to qualify it as a corporation or some other particular form of business structure.”[2] There is neither a requirement of filing papers nor any formal partnership agreement.[3][KU1] 

For tax purposes, a partnership is considered an aggregate of partners, so they pay the business’s taxes rather than paying on the partnership’s taxes.[4]This is also known as flow-through taxation, where the entity is viewed as separate from the owners.[5]

For business purposes, each partner is considered an agent of the partnership.[6] An act by any partner could bind the partnership if it is within the “ordinary course [of] the partnership business.”[7] If any partner acts outside the scope of the “ordinary course of the partnership business,” the partnership may still be bound by the act if it was authorized by the other partners.”[8][KU2] 

[1] Revised Unif. P’ship Act § 202(a) (2013-2014).

[2] David G. Epstein, Richard D. Freer, Michael J. Roberts & George B. Shepherd, Business Structures 65 (West, 3d ed. 2010).

[3] Id. (“Creating a partnership does not require that papers be filed in the public records. Partnership law does not even require that there be a written partnership agreement”).

[4] Id. at 63.

[5] Id.

[6] Revised Unif. P’ship Act § 301(1) (2013-2014).

[7] Id.

[8] Id. at §301(2).

A private equity fund is a type of limited partnership made up of investors and a private equity firm.[1] The investors provide capital,[2] and the private equity firm manages that capital.[3] Together, the investors and the firm own the fund. In this way, a private equity fund matches individuals with investment management expertise but limited funds with individuals that have disposable funds but little investment management expertise.[4] 

After a fund is created, the private equity firm strategically selects investments that fit within the fund’s investment portfolio.[5] Since the fund’s profits are wholly dependent on the success of its investments, a private equity fund generally carries more risk than other financial intermediaries that pay a fixed rate of return.[6] Further, because a private equity fund carries more risk, it tends to pay investors a higher rate of return than a fixed-rate intermediary.[7]  If an investment fails, the firm that managed the investment is indemnified against the investors, unless the firm’s conduct constituted gross negligence.[8]

[1]See Thomas H. Bell, Barrie B. Covit, Jason A. Herman, Glenn R. Sarno & Michael W. Wolitzer, Private Equity in 33 Jurisdictions Worldwide 108 (Casey Cogut ed. 2010).

[2] Id.

[3] Law Journal Press, Private Equity Funds: Business Structure and Operations § 4.01 (2000).

[4] See id.

[5] Id. at § 1.02.

[6] See id.

[7] See id.

[8] Id.

Private Securities Litigation Reform Act

The Private Securities Litigation Reform Act of 1995 ("PSLRA") amends both the Securities Act and Exchange Act, with the aim to limit frivolous securities lawsuits.[1] In Tellabs, Inc. v. Makor Issues & Rights, Ltd., Justice Ginsberg articulated the Supreme Court’s interpretation of the purpose of the PSLRA:

Private securities fraud actions, however, if not adequately contained, can be employed abusively to impose substantial costs on companies and individuals whose conduct conforms to the law. As a check against abusive litigation by private parties, Congress enacted the Private Securities Litigation Reform Act of 1995 (PSLRA), 109 Stat. 737.[2]

In a typical Rule 10b-5 claim, a plaintiff will commence the action by filing a complaint in federal court. The defendant will then file a motion to dismiss under Rule 12(b)(6) of the Federal Rules of Civil Procedure.[3] If the court determines that the facts alleged in the complaint are sufficient to state a Rule 10b-5 claim, the plaintiff becomes entitled to obtain discovery from the defendant.[4]

Prior to the PSLRA, plaintiffs could proceed with minimal evidence of fraud and use pretrial discovery to seek further proof.[5] This set a very low barrier to initiate litigation, which encouraged the filing of weak or entirely frivolous suits.[6]  The enactment and interpretation of the PSLRA raised the pleading standards, reducing the number of purportedly frivolous Rule 10b-5 lawsuits that survive motions to dismiss.[7]

[1] Ralph C. Ferrara and Philip S. Khinda, Recent Development Federal Agency Focus: Securities and Exchange Commission: SEC Enforcement Proceedings: Strategic Considerations For When the Agency Comes Calling, 51 Admin. L. Rev. 1143, 1183-84 (1999).

[2] Tellabs, Inc. v. Makor Issues & Rights, Ltd., 551 U.S. 308, 311 (2007) (citations omitted).

[3] See generally Fed. R. Civ. P. 12(b)(6).

[4] See generally 17 C.F.R. § 240.10b-5 (2013).

[5] See Tellabs, Inc. v. Makor Issues & Rights, Ltd., 551 U.S. 308, 311 (2007).

[6] See id.

[7] See generally Louie Loss, Joel Seligman & Troy Paredes, Fundamentals of Security Law 1765-89 (6th ed. 2011).

proxy statement is “[a]n informational document that accompanies a proxy solicitation and explains a proposed action (such as a merger) by the corporation.”[1] Proxy solicitation refers to a request issued to a shareholder in a corporation to allow another person to cast a vote for the shareholder.[2] The United States Securities and Exchange Commission (the “SEC”) regulates proxy statements and proxy solicitations.[3] The SEC sets forth the information that must be provided in a proxy statement and generally requires inclusion of a proxy statement with every proxy solicitation.[4] The SEC does not require a proxy statement when a proxy solicitation meets a specific set of guidelines.[5]

It is unlawful to make a misleading statement of material fact in a proxy statement or proxy solicitation.[6] Determining whether or not a statement is material requires a court to perform an objective test that evaluates the significance a reasonable shareholder would attach to the statement in deciding how to vote.[7] To find a violation, it is not necessary to establish that a reasonable shareholder would have changed their vote absent the misleading statement.[8] Rather, the misleading statement will be deemed material if “disclosure of the omitted fact would have been viewed by the reasonable investor as having significantly altered the ‘total mix’ of information made available.”[9]

[1] Black’s Law Dictionary 1347 (9th ed. 2009).

[2] See Id. at 1346.

[3] See 17 C.F.R. § 240.14a (2013).

[4] See 17 C.F.R. § 240.14a-3(a).

[5] See 17 C.F.R. § 240.14a-2.

[6] See 17 C.F.R.. § 240.14a-9(a).

[7] See TSC Industries, Inc. v. Northway, Inc., 426 U.S. 438, 445 (1976).

[8] See id. at 449.

[9] Id. at 449-450.

registration statement is a document that a company must file with the U.S. Securities and Exchange Commission (“SEC”) before it can proceed with a public offering.[1]   The registration statement provides essential facts about the filer, including information about its earnings, distributions, capital structure, and the company’s future.[2] A registration statement generally becomes effective 20 days after it has been filed with the SEC.[3] Once the registration statement becomes effective, the company may begin to sell its securities.[4] The registration statement must also contain the information and be accompanied by the documents specified in Schedule A of 15 U.S.C. § 77aa.[5]

Not all companies that sell securities must file a registration statement: the Securities Act of 1933 allows the SEC to provide for exemptions to the registration statement requirement “as it determines consistent with the public interest and the protection of investors.”[6] The duty of the legal counsel is to ascertain whether costs of filing registration statement can be avoided by relying on an exemption.[7]

[1] See 15 U.S.C. § 77e(a),(c) (2012); James D. Cox & Thomas Lee Hazen, 4 Treatise on the Law of Corporations § 27:11 (3d ed.).

[2] See Cox & Hazen, supra note 1.

[3] 15 U.S.C. § 77h (2012).

[4] See 15 U.S.C. § 77e(a) (2012) (“Unless a registration statement is in effect as to a security, it shall be unlawful for any person, directly or indirectly … to sell such”).

[5] 15 U.S.C. § 77g(a)(1) (2012).

[6] 15 U.S.C. § 77g(b)(2) (2012).

[7] See Cox, Law of Corporations, supra note 1

Rule 10b-5 was promulgated under the broad rule making power granted to the Securities and Exchange Commission by the Security Exchange Act of 1934.[1]  It was written to prevent fraud and abuse in the securities market by promoting free and open markets.[2]  The rule prohibits the following practices in the purchase and sale of securities: “(a) to …defraud, (b) to make any untrue statement of a material fact or to omit to state a material fact necessary in order to make the statements made … not misleading, or (c) to engage in any act … which operates or would operate as a fraud or deceit upon any person.”[3] Although the rule does not define the term material fact, the courts have defined it as information that a reasonable shareholder might with a substantial likelihood find important.[4] 

The prohibition on using deceptive or fraudulent practices or devices in the purchase and sale of securities has been used to extend 10b-5 to cover insider trading.[5] In cases of insider trading, Rule 10b-5 requires “that when potential securities traders have obtained the material information in such a way as to subject them to Rule 10b–5’s reach, they must either abstain from trading or disclose the information prior to trading.”[6]

[1] James D. Cox and Thomas Lee Hazen, Treatise on the Law of Corporations § 12:9 (2012).

[2] Arnold S. Jacobs, Disclosure & Remedies Under the Securities Laws § 15.1 (2013).

[3] 17 C.F.R.  § 240.10b-5.

[4] See e.g., TSC Indus., Inc. v. Northway, Inc., 426 U.S. 438, 449 (1976). See also Cox & Hazensupra note 1.

[5] Thomas Lee Hazen, Treatise on the Law of Securities Regulations § 12.17 (2013) (“The securities laws do not expressly prohibit trading on the basis of nonpublic information. Instead, the prohibition has been crafted out of the Securities Exchange Act's antifraud provisions found in section 10(b) and SEC Rule 10b–5”).

[6] Id.

The U.S. Securities and Exchange Commission, or SEC, was created in 1934 as a result of the Securities Exchange Act of 1934.[1] The Act was a response to the Great Depression.[2] [KU1] The SEC consists of five presidentially-appointed commissioners, each of whom is appointed for a five-year term, on a staggered basis.[3] Additionally, only three commissioners can be of the same political party.[4] The SEC is headquartered in Washington, D.C., and is split into five divisions, consisting of 23 offices in total.[5] The five commissioners form the Commission, whose task is to:

1.     “Interpret and enforce federal securities laws; 2.     Issue new rules and amend existing rules; 3.     Oversee the inspection of securities firms, brokers, investment advisers, and ratings agencies; 4.     Oversee private regulatory organizations in the securities, accounting, and auditing fields; and 5.     Coordinate U.S. securities regulation with federal, state, and foreign authorities.”[6]

The five divisions of the SEC are the Division of Corporation Finance, Division of Trading and Markets, Division of Investment Management, Division of Enforcement, and Division of Economic and Risk Analysis.[7] The Division of Corporate Finance is largely tasked with reviewing and overseeing documents that corporations file to the public with pertinent investment information.[8] They are reviewed for both accuracy and completeness. The responsibilities for the Division of Trading and Markets include oversight of markets, looking for lapses in fairness and efficiency.[9]

The Division of Trading and Markets also oversees market participants and oversees the Securities Investor Protection Corporation, a public safeguard against brokerage houses.[10] The Division of Investment Management helps to protect investors and promotes economic growth by overseeing and regulating the investment management industry.[11] Next, the Division of Enforcement is charged with investigating, enforcing, and prosecuting any breaches to the fullest extent of the law.[12] Finally, the Division of Economic and Risk Analysis encourages fairness by protecting investors and conducting economic analyses on the markets with respect to market policy development.[13]


[1] The U.S. Sec. & Exch. Comm’n, The Investor’s Advocate: How the SEC Protects Investors, Maintains Market Integrity, and Facilitates Capital Formation, sec.gov, www.sec.gov/about/whatwedo.shtml (last modified Jun. 10, 2013).

[2] Id.

[3] Id.

[4] Id.

[5] Id.

[6] Id.

[7] Id.

[8] Id.

[9] Id.

[10] Id.

[11] Id.

[12] Id.

[13] Id

The Securities Act of 1933 regulates the offer and sale of securities to the public.[1] The Act’s regulations are meant to ensure that public investors are able to purchase securities at an accurate market price.[2] The Act promotes accurate pricing by ensuring that investors are able to access reliable information.[3]  To this end, the Act requires companies to disclose relevant financial information and imposes liability on companies that disclose false or misleading information.[1]

Under the Act, every company that offers or sells its securities to the public must disclose all “information that a reasonable investor might consider important when making an investment decision.”[4] A company discloses this information in a detailed registration statement, which is filed with the Securities and Exchange Commission and made available to the public.[5]

The Act is enforced when either 1) the Securities and Exchange Commission brings a criminal suit against a company that provides false or misleading information,[6] or 2) an individual investor may files a civil action to recoup losses caused by the disclosure of false or misleading information.[7]

[1] See Marc  I. Steinberg & Brent A. Kirby, The Assault on Section 11 of the Securities Act: A Study in Judicial Activism, 63 Rutgers L. Rev. 1, 4 (2010).

[2] Note, Disclosure of Future-Oriented Information Under the Securities Laws,88 Yale L.J. 338, 339-41 (1978) [hereinafter Securities Laws].

[3] See Steinberg et al., supra note 1.

[4] Affiliated Ute Citizens of Utah v. U.S., 406 U.S. 128, 153-54 (1972).

[5] See 15 U.S.C. § 77b(a)(8)-(10). 

[6] Id. at § 77t.

[7] Id. at § 77k.

The Securities Exchange Act of 1934 [1](“the Exchange Act”) primarily protects investors in the secondary market for securities, i.e. the market for securities after their initial issuance by the corporation.[2] The Exchange Act protects investors through[3]: (1) forcing mandatory disclosures on corporations to inform potential investors (through 10K, 10Q, and 8K filings);[4] (2) regulation of participants in the securities market, such as securities exchanges and broker-dealers[5], (3) requiring registration of all securities traded on securities exchange[6]; and (4) prohibiting fraudulent or deceitful trading practices in securities trade[7]. The Exchange Act also creates the Securities and Exchange Commission (SEC) and grants it the power to enforce the Act.[8]

[1] Securities Exchange Act of 1934, Pub. L. No.  73–291, 48 Stat. 881 (1934) [hereinafter “Exchange Act”] (codified at 15 U.S.C. § 78a et seq.).

[2] Securities Exchange Act of 1934 (the Exchange Act), Legal Information Institute, www.law.cornell.edu/wex/securities_exchange_act_of_1934 (last visited September 19, 2013).

[3] See generally id.

[4] See Exchange Act, supra note 1, §§ 13 a, 14 (a)­–(c).   

[5] See Exchange Act, supra note 1, §§ 5–6.

[6] See Exchange Act, supra note 1, § 12 (a)–(b).

[7] See Exchange Act, supra note 1, § 12 (b); 17 C.F.R. § 240.10b-5.

[8] See Exchange Act, supra note 1, § 4.

Securities Fraud (including Rule 10b-5) describes a variety of distinct causes of action,[1] both civil and criminal, for fraudulent activities, “all of which involve the deception of investors or the manipulation of financial markets.”[2] It includes private actions relating to the purchase or sale of securities that arise from a knowing material misrepresentation or omission that results in a loss.[3]

Private actions are rooted in Section 10(b) of the Securities Exchange Act of 1934, which forbids the use of any manipulative or deceptive information provided in connection with the purchase or sale of a security.[4]  Section 10(b) is enforced by the U.S. Security and Exchange Commission’s Rule 10b-5. Under Rule 10b-5, it is unlawful to:

(a) Employ any device, scheme, or artifice to defraud,

(b) Make any untrue statement of a material fact or to omit to state a material fact necessary in order to   make the statements made ... not misleading, or

(c) Engage in any act, practice, or course of business which operates or would operate as a fraud or deceit upon any person, in connection with the purchase or sale of any security.[5]

This list is not exhaustive, and the activities prosecuted as securities fraud are subject to a developing definition based on a “case-by-case evolution of statutory standards.”[6]

[1] In re Initial Pub. Offering Sec. Litig., 399 F. Supp. 2d 298, 303 (S.D.N.Y. 2005), aff'd sub nom. Tenney v. Credit Suisse First Boston Corp., Inc., 05-3430-CV, 2006 WL 1423785 (2d Cir. May 19, 2006).

[2] Securities Fraud Awareness & Prevention Tips, FBI.gov (last visited September 8, 2013) www.fbi.gov/stats-services/publications/securities-fraud.

[3] Tellabs, Inc. v. Makor Issues & Rights, Ltd., 551 U.S. 308, 319 (2007) (explaining that a private plaintiff must prove that the defendant acted with an “intent to deceive, manipulate, or defraud”); Amgen Inc. v. Connecticut Ret. Plans & Trust Funds, 133 S. Ct. 1184, 1206 (2013).

[4] Tellabs, 551 U.S. at 318.

[5] Id. at 1193 n.2. Examples of securities fraud include high yield investment fraud, Ponzi schemes, pyramid schemes, advanced fee schemes, foreign currency fraud, broker embezzlement, hedge fund related fraud, and late day trading. Securities Fraud Awareness & Prevention Tips, supra note 2.

[6] Black & Co., Inc, 1984 WL 906627 at *20, Admin. Proc. File No. 3-3460 (S.E.C. July 12, 1974) (“[T]he definition of securities fraud . . . seems to take form in a seemingly infinite number of factual variants, mutations, and permutations.”).

shareholder is a person or entity in whose name shares are registered in the records of a corporation.[1]  A shareholder may own all or part of the shares of proprietary interests in a corporation.[2]  The corporation may make distributions to shareholders subject to restrictions set forth in the articles of incorporation.[3] The class of shares issued to shareholders also determines the rights shareholders have within the corporation and their proprietary interests.[4]  Notwithstanding a shareholder’s ownership interests in a corporation, shareholders and corporations are different entities.[5] Shareholders are not personally liable for the acts or debt of the corporation unless a corporation is deemed to be a mere “instrumentality” or “alter-ego” of a majority shareholder.[6]

[1] See Model Bus. Corp. Act § 1.40 (21) (1984).

[2] See id. at § 1.40 (22).

[3] See id. at §6.40 (a).  In addition to making distributions subject to the articles of incorporation, subsection (a) of §6.40 of the Model Business Corporations Act states that such distributions also are subject to the restrictions set forth in subsection (c).  Id. Subsection (c) states that:

No distribution may be made if, after giving it effect: (1) the corporation would not be able to pay its debts as they become due in the usual course of business; or (2)  the corporation’s total assets would be less than the sum of its total liabilities plus (unless the articles of incorporation permit otherwise) the amount that would be needed, if the corporation were to be dissolved at the time of the distribution, to satisfy the preferential rights upon dissolution of shareholders whose preferential rights are superior to those receiving the distribution.

Id. at §6.40 (c).

[4] See e.g., id. at § 6.23(b).

[5] Steven G. Marget, Shareholder Liability – Lakota Girl Scout Council, Inc. v. Havey Fund-Raising Management, Inc. – A Single Factor Test?, 3 J. Corp L. 219, 219 (1977-78).

[6] Id. See also Model Bus. Corp. Act § 6.22.

Vicarious liability, sometimes referred to as respondeat superior,[1] is the “[l]iability that a supervisory party bears for the actionable conduct of a subordinate or associate based on the relationship between the two parties.”[2]  Vicarious liability is “essentially a form of strict liability” because it puts liability on the non-acting corporation for the conduct of its employees and agents.[3]  This is of particular importance to corporations because “[they] can only act through their employees or agents.”[4]  Vicarious liability is also of great importance to potential plaintiffs who are in search of “deep pockets.”[5]

When determining whether a corporation is vicariously liable for the criminal acts of its employees or agents, courts look to see whether their conduct was within the scope of employment or agency and whether they intended to benefit the corporation.[6]  “[I]f the employee or agent acts only in his or her own self-interest, vicarious criminal liability would not be imposed upon the corporation.”[7]

[1] Maria M. Romani, Civil Rico and Vicarious Corporate Liability: Shrinking Civil Rico Back to Its Originally Intended Congressional Size, 15 Ohio N.U. L. Rev. 695, 698 (1988) (citing W. Keeton Et Al., Prosser And Keeton On The Law Of Torts § 69 (5th ed. 1984) (“Vicarious liability is often referred to by its Latin name of respondeat superior,” and the two terms are sometimes used interchangeably).

[2] Black's Law Dictionary 18 (9th ed. 2009).

[3] Romani, supra note 1, at 698. See § Burlington Industries Inc. v. Ellerth, 524 U.S 742, 744 (1998) (discussing how employee’s or agent’s conduct must have been “in the scope of their authority or employment”).

[4] Romani, supra note 1, at 698-99, (emphasis added) (internal quotation marks omitted) (“Corporations as employers or principals may incur vicarious liability for the torts committed by their employees or agents.  As an employer, corporations are civilly liable for the tortious acts of their employees that are committed within the scope of their employment.”).

[5] Id. at 697 (internal quotation marks omitted) (“[V]icarious liability is often the only way to ensure that a deep-pocket defendant will be joined in the lawsuit.”).

[6] See U.S. v. Cincotta689 F.2d 238, 241-42 (1st Cir. 1982).

[7] Romani, supra note 1 at 700.

Arbitrage is a form of trading based upon a disparity in the quoted price of equivalent commodities, securities, or bills of exchange.[1] There are four common types of arbitrage. First, time arbitrage involves the purchase of a commodity against the present sale of that commodity for future delivery.[2]Second, space arbitrage is the purchase of a commodity in one market against the sale of that commodity in another market.[3] Third, kind arbitrage consists of the purchase of a security that is convertible into a second security, together with the simultaneous offsetting sale of that second security.[4] Fourth, risk arbitrage involves investing in securities that are subject to disposition.[5] This transaction results in an economic return where the value realized from the disposition is greater than the cost of the investment.[6]

1] Falco v. Donner Foundation, Inc., 208 F.2d 600 (2d Cir. 1953).

[2] Id. at 7.

[3] Id. For example, the purchase of a commodity in New York against the sale of that commodity in London. Id.

[4] Id.

[5] Arnold S. Jacobs, Section 16 of the Securities Exchange Act, § 6:1 (2013). Types of dispositions include exchange offers, cash tender offers, corporate reorganizations, or liquidations. Id.

[6] Id.

The Board of Directors (Board of Governors, Board of Managers) of a corporation is the source of authority for all corporate affairs.[1] In modern times, the board of directors delegates management authority to executive officers of the corporation to manage the day-to-day operations of the corporation while serving as a supervising body.[2]  

The number of directors sitting on the board at a given time is determined by the corporation’s articles of incorporation or its bylaws, subject to amendments.[3] Modern statutes do not require specific qualification for directors, but a corporation may prescribe qualifications in its articles of incorporation or bylaws.[4] Directors are elected at the corporation’s annual shareholders’ meeting[5] and the term expires at the following annual shareholders’ meeting[6] unless the articles of incorporation adopt a staggered term.[7] A director may resign from the board by written notice, or be removed from the board by shareholders in a special meeting or through judicial proceeding.[8] Vacancies on the board of directors may be filled by shareholders or board of directors’ election.[9]

Examples of a public corporation’s oversight responsibilities are stated in the Modern Business Corporation Act.[10]  The board of directors, as a group, can only act in two ways: first, the board of directors can approve a resolution at a meeting;[11] second, the board of directors can act by written consent.[12] The board of directors may create sub-committees in accordance with the corporation’s bylaws and appoint directors to the subcommittees to advise the management.[13] The board of directors may also appoint officers of the corporation in accordance with the bylaws and distribute assignments to manage the corporation.[14]

The board of directors has fiduciary duties to the corporation including the duty of good faith, the duty of loyalty, and the duty of care.[15]

[1] Model Bus. Corp. Act § 8.01(b) (2002).

[2] See Robert W. Hamilton & Richard D. Freer, The Law of Corporations in a Nutshell 80 (6th ed. 2011). 

[3] Model Bus. Corp. Act § 8.03(a)–(b).

[4] Id. § 8.02.

[5] Id. § 8.03(c).

[6] Id. § 8.05(b).

[7] Id. § 8.06.

[8] Id. §§ 8.07(a), 8.08, 8.09(a).

[9] Id. § 8.10(a)(1)–(2) (2002).

[10] Id. § 8.01(c).

[11] Id. § 8.20(a).

[12] Id. § 8.21.

[13] Id. § 8.25(a).

[14] Id. § 8.40(a)–(b).

[15] See id. § 8.40(a).

The business judgment rule is a legal principle that shields directors, officers, and other agents of a corporation from liability for acts or omissions taken in good faith and with due care.[1] The burden of rebutting the application of the business judgment rule rests on the shareholder-plaintiff challenging a business decision.[2] The shareholder-plaintiff must provide evidence that officers or directors of a corporation breached any of their fiduciary duties of good faith, loyalty or due care, in reaching their business decision.[3]

The rule is based on the presumption that officers and directors of a corporation will make business decisions on an informed, good faith basis and in the best interests of the company.[4] The standard justifications for the business judgment rule two-folded: (1) “judges lack competence in making business decisions,” and (2) “the fear of personal liability will cause corporate managers to be more cautious and [as a result] fewer talented people [will be] willing to serve as direction.”[5] 

[1] 18B Am. Jur. 2d Corporations § 1470 (2006).

[2] Cede & Co. v. Technicolor, Inc., 634 A.2d 345, 361 (Del. 1993), modified in other respects, 636 A.2d 956 (Del. 1994).

[3] Id.

[4] Id.

[5] Daniel R. Fischel, The Business Judgment Rule and the Trans Union Case, 40 Bus. Law. 1437, 1439 (1985). 

Channel stuffing is a method of earnings manipulation.[1] It is the practice of encouraging distributers or retailers to take on more inventory than they can sell in the normal course of business.[2] The purpose of channel stuffing is to artificially inflate revenues in a given reporting period.[3] The practice is fraudulent “when it is used . . . to book revenues on the basis of goods shipped but not really sold because the buyer can return them.”[4] For example, a company may stuff the channel by over-shipping to retailers despite low demand, only to have the product returned en masse when the retailer cannot sell the product.[5] In such cases, channel stuffing is illegal.[6] That said, “[c]hannel stuffing is not fraudulent per se.”[7] Courts have identified situations in which there are legitimate reasons for businesses to engage in the practice.[8] For example, a distributor may offer bulk-pricing discounts or provide retailers with extra inventory during holiday seasons.[9] In such cases, channel stuffing is considered a legitimate business practice.[10]

[1] See Greebel v. FTP Software, Inc., 194 F.3d 185, 202 (1st Cir. 1999).

[2] See Id.

[3] See id.

[4] Makor Issues & Rights, Ltd. v. Tellabs Inc., 513 F.3d. 702, 709 (7th Cir. 2008).

[5] Id.

[6] See id.

[7] Garfield v. NDC Health Corp., 466 F.3d 1255, 1261 (11th Cir. 2006).

[8] Greebel, 194 F.3d at 202-03.

[9] See Johnson v. Tellabs, Inc., 262 F. Supp 2d. 937, 950 (N.D. Ill. 2003) (“In the business world, there certainly is nothing inherently wrong with offering incentives to customers to purchase products.”); Aldridge v. A.T. Cross Corp., 284 F.3d 72, 81 (1st Cir. 2002) (“These figures might well be explained by holiday season sales.”).

[10] See Greebel, 194 F.3d at 202-03.

In Citizens United v. Federal Election Comm’n, the Supreme Court held that the First Amendment prohibits the government from restricting political expenditures by corporations.[1]

In Citizens, a non-profit corporation sued the Federal Election Commission for declaratory and injunctive relief because the non-profit feared that it could be subject to civil and criminal penalties for producing and airing a documentary aimed at U.S. Senator Hillary Rodham Clinton, a Democratic candidate in the 2008 Presidential election.[2]

The Court considered whether it was constitutional to prohibit a corporation from using its general treasury to fund electioneering communications.[3] The Court held that such restrictions were unconstitutional because political speech was an essential mechanism of democracy, and as such, corporations should be afforded protection under the First Amendment.[4]

            The decision in Citizens overturned the Supreme Court’s prior holding in .58 U.S. 310, urt'ngat Congress iceic return wherdifference between the purchase price and the value realized from the dispositiMcConnell v. Federal Election Comm’n, in which the Supreme Court upheld limits on electioneering communications.[5] As a result, Citizens prompted the proliferation of super PACs (political action committees), large organizations that solicit campaign contributions and engage in unlimited political spending due to their legal independence from campaigns.[6]

 [1] Citizens United v. Fed. Election Comm'n, 558 U.S. 310, 311(2010).

[2] Id.

[3] Id. Specifically, the Court considered whether the prohibition mandated under section 441(b) of the Bipartisan Campaign Reform Act was constitutional. Id.

[4] See id. at 313.

[5] Id. at 312; see also McConnell v. Fed. Election Comm’n, 540 U.S. 93 (2003).

[6] See Matt Bai, How Much Has Citizens United Changed the Political Game?, N.Y. Times (July 17, 2012)www.nytimes.com/2012/07/22/magazine/how-much-has-citizens-united-changed-the-political-game.html?pagewanted=1&_r=0.

Corporate governance is a term for the method by which corporations are managed, directed, and controlled.[1] The main purpose of corporate governance is to define the corporation’s objectives; the obligations of the corporation’s officers, directors, and shareholders; and the relationships between those players.[2] Objectives provide direction for a corporation’s board and managers when acting on behalf of the company.[3] Corporations are generally created to provide both economic and legal benefits for their shareholders.[4] Therefore, the ultimate goal for most corporations is to maximize profits for the shareholders.[5]

State laws and regulations impose various procedural requirements that affect corporate governance. [6] For example, many jurisdictions require a board of directors and regulate their actions, require certain meetings, regulate voting, and regulate the appointment, conduct, and removal of officers through statute.[7]

[1] Organisation for Economic Co-Operation and Development, 11 (2004)www.oecd.org/daf/ca/corporategovernanceprinciples/31557724.pdf.

[2] See id.

[3] See id.

[4] See Alpert v. 28 William St. Corp., 478 N.Y.S.2d 443, 448 (Sup. Ct. 1983).  

[5] See id.

[6] See CTS Corp. v. Dynamics Corp. of America, 481 U.S. 69, 90 (1987).

[7] See Model Bus. Corp. Act §§ 7.01, 7.20, 8.01, 8.40 (2002).

Corporate stakeholder is a phrase[KU1]  that is[KU2]  coined corresponding to, but distinct from[PH3] , the traditional concept of “corporate stockholders.”[1]Corporate stakeholder, in its most literal sense, means all groups (including stockholders) that have a stake in the decisions and actions of the corporation.[2]  Of the numerous groups of corporate stakeholders that fit this literal definition, R. Edward Freeman and David L. Reed proposed two tiers of further definitions for the term (or phrase) “corporate stakeholder,” according to the extent of the stakes involved in the corporation’s survival:

  • The Wide Sense of Stakeholder: Any identifiable group of individual who can affect the achievement of an organization’s objectives or who is affected by the achievement of an organization’s objectives. (Public interest groups, protest groups, government agencies, trade associations, competitors, unions, as well as employees, customer segments, shareowners, and others are stakeholders, in this sense.)
  • The Narrow Sense of Stakeholder: Any identifiable group or individual on which the organization is dependent for its continued survival. (Employees, customer segments, certain suppliers, key government agencies, shareowners, certain financial institutions, as well as others are all stakeholder in the narrow sense of the term.) [3]

James E. Post, Lee E. Preston, and Sybille Sachs proposed another definition of “corporate stakeholder,” which contends that “[t]he stakeholders in a corporation are the individuals and constituencies that contribute, either voluntarily or involuntarily, to its wealth-creating capacity and activities, and that are therefore its potential beneficiaries and/or risk bearers[PH4] .” [4]

The two definitions are congruent with one exception: Freeman and Reed’s definition includes adversary groups. Their rationale is that “from the standpoint of corporate strategy, stakeholder must be understood in the wide sense: strategies need to account for those groups who can affect the achievement of the firm’s objectives.”[5] Post et al.’s proposed definition however, leaves no room for adversary groups. Their rationale is that “corporations should aim for mutually beneficial (and certainly not harmful) relationships with stakeholders.”[6]

[1] See R. Edward Freeman & David L. Reed, Stockholders and Stakeholders: A New Perspective on Corporate Governance, 25 Cal. Mgmt. Rev. 88, 88 (1983).

[2] See id. at 89.

[3] Id. at 91 (emphasis in original).

[4] James E. Post, Lee E. Preston & Sybille Sachs, Redefining the Corporation: Stakeholder Management and Organizational Wealth 19 (2002).

[5] Freeman & Reed, supra note 1, at 91.  

[6] Post et al., supra note 4, at 19.


 [KU1]Would it be better to refer to Corporate Stakeholder as a “term” rather than a “phrase”?  This is more of a style issue.

 [KU2]Did you mean to say “was”?

 [PH3]Added commas to separate phrase.

 [PH4]I suggest a paraphrasing of this quote along the lines of: potential beneficiaries and/or risk bears who contribute, voluntarily or involuntarily, to a corporations wealth creation. This will also help to eliminate excess words.

corporation is a formal business association that exists as a distinct legal entity.[1]

Corporations must be formally established through Articles of Incorporation.[2]  Articles of Incorporation must include a corporate name with a suffix signaling limited liability, such as “Ltd.,” “Corp.,” or “Co.”[3] Articles of Incorporation must also include the number of authorized shares, or the maximum amount of shares that the corporation may issue.[4] Finally, the Articles of Incorporation must include the address of an initial registered agent, as well as the name and address of the person incorporating the business.[5]

A key feature of corporations is limited liability of the shareholders or owners of the corporation.[6] The maximum liability to shareholders or owners resulting from the business would not typically exceed their investment in the business.[7]

Corporations could be public or closely-held. Ownership in a public corporation is transferrable through a primary market, in which the corporation sells its own shares.[8] For a closely held corporation, shares are not generally traded on a securities exchange, nor are they readily transferrable.[9]

[1] James D. Cox & Thomas Lee Hazen, Treatise on the Law of Corporations §1:2 (2012).

[2] Id., at § 3:4.

[3] Id.

[4] Id.

[5] Id.

[6] Id., at § 1:2.

[7] Id.

[8] Id., at § 1:20.

[9] Id., at § 14:1.

In a derivative action, a shareholder brings a lawsuit on behalf of a corporation to enforce a claim.[1] The shareholder must represent the best interests of similarly situated shareholders or members.[2] Additionally, the shareholder must state in his pleading any demand made upon the board of directors to “obtain the desired action”[3] and “the reasons for not obtaining the action or not making the effort.”[4] However, this rule may be excused if the shareholder shows that demand would have been futile.[5]

There are two factors for determining demand futility: (1) whether there is reasonable doubt that the directors are “disinterested and independent” and (2) whether there is reasonable doubt that “the challenged transaction was otherwise the product of a valid exercise of business judgment.”[6] Only a finding of one of the factors is needed for demand to be excused.[7]

A director’s interest means that he “stands to gain or lose personally and materially depending on the board’s decision.”[8] “Independence means that a director’s decision is based on the corporate merits of the subject before the board rather than extraneous considerations or influences.”[9]

[1] Fed. R. Civ. P. 23.1(a).

[2] Id.

[3] Fed. R. Civ. P. 23.1(b)(3)(A).

[4] Fed. R. Civ. P. 23.1(b)(3)(B).

[5] Jerue v. Millett, 66 P.3d 736, 743 (Alaska 2003).

[6] Aronson v. Lewis, 473 A.2d 805, 814 (Del. 1984).

[7] Brehm v. Eisner, 746 A.2d 244, 256 (Del. 2000).

[8] Sonus Networks, Inc. v. Ahmed, 499 F.3d 47, 67 (1st Cir. 2007).

[9] Aronson, 473 A.2d at 816.

A shareholder derivative suit, or derivative action, is a lawsuit brought by a shareholder on behalf of a corporation.[1] “[T]he . . . object of the derivative suit mechanism is to permit shareholders to file suit on behalf of a corporation when the managers or directors of the corporation, perhaps due to a conflict of interest, are unable or unwilling to do so, despite it being in the best interests of the corporation.”[2] To bring a derivative suit, the complaint must allege “the plaintiff was a shareholder or member at the time of the transaction complained of, or that the plaintiff’s share or membership later devolved on it by operation of law.”[3] In most states, the derivative plaintiff must demonstrate that she will adequately represent the interests of the corporation.”[4] In many states, statutes also require that shareholders make a written demand of the board for the corporation to vindicate its claim.[5] If the board accepts the demand, the corporation will proceed on its own behalf. If the board rejects the demand, the shareholders may proceed with the derivative action.[6]

[1] David G. Epstein, Richard D. Freer, Michael J. Roberts & George B. Shepherd, Business Structures 271 (3d ed. 2010).

[2] First Hartford Corp. Pension Plan & Trust v. United States, 194 F.3d 1279, 1295 (Fed. Cir. 1999).

[3] Fed. R. Civ. P. 23.1(b)(1).

[4] Robert W. Hamilton & Richard D. Freer. The Law of Corporations in a Nutshell 358 (6th ed. 2011).

[5] Id. at 359 ̶60.

[6] Epstein at 278.

Derivatives are financial commodities, in the form of a contract, that derive value from another source.[1]  Examples of the types of sources that can be used to value derivatives are foreign currencies, interest rates, and treasury bonds.[2]  Derivatives are often speculative in nature.[3]

Some derivatives can be sold in over-the-counter swaps, meaning that they are not sold on a national exchange and are not registered with a regulatory agency.[4]  However, with the introduction of the Dodd-Frank Wall Street Reform and Consumer Protection Act, some previously unregulated derivative trades must now go through exchanges or clearinghouses prior to being sold.[5]  Decisions over how to regulate derivative markets are handled by the Commodity Futures Trading Commission and the Securities and Exchange Commission.[6]

[1] Black’s Law Dictionary 509 (9th ed. 2009).

[2] Id.

[3] Procter & Gamble Co. v. Bankers Trust Co., 925 F. Supp. 1270, 1275 (S.D. Ohio 1996).

[4] Id. at 1279.

[5] Mark D. Sherrill, Are There Futures In Your Futures? A Primer on Bankruptcy, Cleared Swaps and Futurization, 32 Am. Bankr. Inst. L. Rev. 16 (2013).

[6] Id.

The Dodd-Frank Wall Street Reform and Consumer Protection Act, enacted on July 21, 2010, is a United States federal law which, among other purposes, aims “to promote the financial stability of the United States by improving accountability and transparency in the financial system, to end 'too big to fail' [phenomenon in the banking system], [and] to protect consumers from abusive financial services practices.”[1]  

The Act attempts to achieve its purpose through several means: First, the Act created the Financial Stability Oversight Council to monitor financial institutions and to respond to any potential risks to the U.S. economy.[2] Second, the Act created parallel regulatory regimes for the U.S. Commodity Futures Trading Commission and the Securities Exchange Commission to regulate the swaps market.[3]  Third, the Act enacted a requirement for large financial institutions to retain more of the credit risks of securitizations, where they consolidate debt to sell to investors.[4]  Fourth, the Securities and Exchange Commission will work to protect and promote investors by holding Credit Rating Agencies liable for abuse.[5]  Fifth, the Act incorporated The Volcker Rule to regulate proprietary trading and investments.[6]  Finally, the Act reformed the regulation of mortgage lending to ensure fair and safe consumer lending practices.[7]

[1] Dodd-Frank Wall Street Reform and Consumer Protection Act, H.R. 4173, 111th Cong. (2010).  .

[2] The Dodd-Frank Act: A Cheat Sheet 4, Morrison & Foerster, LLP (2010),www.mofo.com/files/uploads/images/summarydoddfrankact.pdf (last visited October 19, 2013).

[3] Id. at 11.

[4] Id. at 8.

[5] See id. at 16.

[6] See Brief Summary of the Dodd-Frank Wall Street Reform and Consumer Protection Act 12, U.S. Sen. Committee on Banking, Housing, and Urban Affairswww.banking.senate.gov/public/_files/070110_Dodd_Frank_Wall_Street_Reform_comprehensive_summary_Final.pdf(last visited October 19, 2013).

[7] See id. at 9.

Equity is a financial interest an owner has in a company.[1] This financial interest can be referred to by different names, including shareholders’ equity for corporations.[2] An equity owner holds a share that is “[o]ne of [a] definite number of equal parts into which the capital stock of a corporation . . . isdivided.”[3] Equity can be calculated as the difference in value between the company’s total assets and its total liabilities.[4] When a company’s liabilities exceed its assets, it may be characterized as having zero equity,[5] being insolvent,[6] or both.

[1] Black’s Law Dictionary 619 (9th ed. 2009)

[2] Id., at 1215. 

[3] Id., at 1500. 

[4] In re Lifschultz Fast Freight, 132 F.3d 339, 350 (7th Cir. 1997). 

[5] Id.

[6] 11 U.S.C. § 101(32) (2012).

The False Claims Act (“FCA”) imposes liability on any person who knowingly makes or uses a false statement which causes the government or a governmental program to make payment on or approve a false or fraudulent claim.[1] In an FCA case, the government may file suit directly or a private person may file suit on the government’s behalf.[2] If a private person files an FCA claim, that person is referred to as a qui tam relator and may recover damages on the government’s behalf.[3] Since 1986, the FCA has been repeatedly amended to make it more plaintiff-friendly.[4]

[1] Allison Engine Co., Inc. v. U.S. ex rel. Sanders, 553 U.S. 662 (2008); see also 31 U.S.C. § 3729.

[2] 31 U.S.C. § 3730(b).

[3] Timson v. Sampson, 518 F.3d 870, 872 (11th Cir. 2008).

[4] See Michael Volkov,The Six Most Significant Recent Amendments to the False Claims Act, JDSupra.com (July 23, 2012)www.jdsupra.com/legalnews/the-six-most-significant-recent-amendmen-50390/.

Fiduciary duty is the “duty of utmost good faith, trust, confidence, and candor owed by a fiduciary (such as a lawyer or corporate officer) to the beneficiary (such as a lawyer’s client or a shareholder).”[1] Fiduciary duty also includes “a duty to act with the highest degree of honesty and loyalty toward another person and in the best interests of the other person (such as the duty that one partner owes to another).”[2] Judge Benjamin Cardozo described the scope of the duties that one partner owes to another partner as “the duty of finest loyalty . . . Not honesty alone, but the punctilio of an honor the most sensitive, is then the standard of behavior.”[3]

Fiduciary duties owed by corporate officers and directors to their corporations fall into two general categories: (1) the duty of care, and (2) the duty of loyalty.[4] In cases where action by directors leads to loss for the corporation, courts have developed the “business judgment rule” to assess whether those corporate officers and directors have breached their duty of good faith[KU1] .[5]

As part of the duty of care, directors are expected to monitor the performance of the company’s CEO as well as other senior managers assigned with the daily management of the company.[6] The duty of loyalty can be best understood as “a person’s duty to not engage in self-dealing or otherwise use his or her positions to further personal interests rather than those of the beneficiary.”[7]

The scope of fiduciary duties is broader in partnerships than it is in the context of corporations.[8] Fiduciary duties of partners may not be waived in or eliminated by partnership agreements.[9]  

[1] Black’s Law Dictionary 581 (9th ed. 2009).

[2] Id.

[3] Meinhard v. Salmon, 164 N.E. 545, 546 (N.Y.1928).

[4] Joseph Shade, Business Associations in a Nutshell 185 (3d ed. 2010).

[5] Id.  Compare Shlensky v. Wrigley, 237 N.E.2d 776, 781 (Ill. App. 1968) (holding that in the absence of a clear showing of dereliction of duty by directors, the court will not require directors to forgo their business judgment), with Smith v. Van Gorkom, 488 A.2d 858, 872 (Del. 1985) (holding that under the business judgment rule there is no protection for directors who exercise unintelligent or unadvised judgment).

[6] Shade, supra note 3, at 193.

[7] Black’s Law Dictionary 581 (9th ed. 2009).

[8] Shade, supra note 3, at 231.

[9]See Revised Unif. P’ship Act § 103 (2013-2014).  However, partnership agreements may provide standards that can be used to define the scope of and how to evaluate partners’ performance of their fiduciary duties.  SeeRevised Unif. P’ship Act § 103 cmt. 4 (2013-2014 ).

The Foreign Corrupt Practices Act of 1977 (“FCPA”) has two primary functions.[1] First, the FCPA discourages corporate bribery by prohibiting certain classes of persons and entities from making payments to foreign government officials in order to obtain an unfair advantage.[2] However, the FCPA does not prohibit payments made to foreign officials if they are meant to expedite or ensure the performance of a “routine governmental action.”[3]

Second, the FCPA imposes certain accounting and filing requirements on companies with securities listed in the United States.[4] These provisions require a covered party to make and keep records that accurately and fairly reflect its transactions. Additionally, they require these parties to devise and maintain a sufficient system of internal accounting controls.[5] A party violates these provisions if it knowingly circumvents or fails to implement a system of internal accounting controls or knowingly falsifies records.[6]

[1] See 15 U.S.C. § 78dd-1, et seq.

[2] Foreign Corrupt Practices Act, An Overview Department of Justice,www.justice.gov/criminal/fraud/fcpa/ (last visited Jan. 1, 2014). The FCPA covers persons and entities that include U.S. citizens, nationals, residents, or any foreign businesses that have their principal place of business in the United States. Id.

[3] See 15 U.S.C. §§ 78dd-1(b), 78dd-2(b) (2013). See also S.R. Rep. No. 95-114, at 10 (1977), reprinted in 1977 U.S.C.C.A.N. 4098, 4108.

[4] See 15 U.S.C. § 78m.

[5] See 15 U.S.C. § 78m(b)(2).

[6] See 15 U.S.C. § 78m(b)(4)-(5).

Form 10-K discloses basic information about a publicly traded company’s performance.[1] It is a mandatory annual filing with the U.S. Securities and Exchange Commission.[2] A Form 10-K addresses all aspects of a company’s financial condition.[3] The primary disclosures concern the company’s financial statements, which include a company’s balance sheet, income statement, and statement of cash flows.[4] This data is supplemented with qualitative insights that include recent financial developments, risk factors, tangible assets, executive compensation, and pending legal proceedings.[5]

[1] Form 10-K, U.S. Securities and Exchange Commission (June 26, 2009) www.sec.gov/answers/form10k.htm.

[2] Id.

[3] See id.

[4] See id.

[5] Id.

The SEC mandates that issuers of securities registered on the national securities exchange file certain information and reports.[1] Included in these filings are quarterly reports on Form 10-Q that disclose corporate developments.[2] Form 10-Q has nearly the same reporting requirements as annual reports, but a key difference between the two is that the financial results in Form 10-Q are unaudited.[3] Although the financial results are unaudited, the act enabling the Form 10-Q  “embodies the requirement that such reports be true and correct[] and a failure to comply with such [requirement] would result in violations of the securities laws.”[4]

Form 10-Q must be filed for each of the first three fiscal quarters of a company's fiscal year and should include a company’s unaudited financial statements. [5] Form 10-Q should also provide a continuing view of the company's financial position during the year.[6] Smaller companies may be subject to different reporting requirements than larger companies.[7]Additionally, companies that have less than $75 million in public equity float will qualify for reduced disclosure requirements.[8]

[1] 15 U.S.C. § 78m(a) (2012).

[2] Id. See SEC v. World-Wide Coin Inv., 567 F. Supp. 724, 759 (N.D. Ga. 1983).

[3] Freeport-McMoran Sulphur, LLC v. Mike Mullen Energy Equip. Res., Inc., No. Civ.A. 03-1664, 2004 U.S. Dist. LEXIS 10197, at *6 (E.D. La. June 3, 2004).

[4] SEC v. Kalvex, Inc., 425 F. Supp. 310, 316 (S.D.N.Y. 1975) (citing duPont v. Wyly, 61 F.R.D. 615, 632 (D. Del. 1973)).

[5] Form 10-Q, www.sec.gov/answers/form10q.htm (last visited Sept. 18, 2013).

[6] Id.

[7] See 17 C.F.R. § 230.405 (2013).

[8] Id.

Generally Accepted Accounting Principles (GAAP) is a series of general principles followed by accountants in preparation of financial statements.[1]GAAP “encompasses all of the changing conventions, rules, and procedures that define accepted accounting practices at a particular point in time . . . .”[2]Although not always mandatory, GAAP should be followed by all entities in order to provide transparency[3] in accounting of financial statements. GAAP became particularly important after the SARBANES–OXLEY ACT OF 2002,[4]which was signed in response to the Enron collapse.[5]

GAAP for non-governmental entities is developed by the Financial Accounting Standards Board,[6] which codified GAAP in the Accounting Standards Codification.[7] The Federal Accounting Standards Advisory Board sets forth the GAAP principles for federal entities in the FASAB Handbook.[8] GAAP for state and local government is established by the Governmental Accounting Standards Board.[9]

[1] U.S. v. Basin Elec. Power Coop., 248 F.3d 781, 786 ( 8th Cir. 2001).

[2] Shalala v. Guernsey Mem’l Hosp., 514 U.S. 87, 101 (1996).

[3] Robert K. Herdman,  Chief Accountant, U.S. Sec. &  Exch. Comm’n, Testimony before H. Comm. of Capital Markets and Government Sponsored Enterprises, 107th Cong. (2002), available atwww.sec.gov/news/testimony/051402tsrkh.htm, (explaining that accounting has to be transparent in order to allow investors and other market entities to make “informed investment decisions through full and fair disclosure”).

[4] Glen M. Vogel, Stuart L. Bass, & Nathan S. Slavin, The Scienter Roadblock has Prevented Litigants From Advancing Down the Sarbanes-Oxley Litigation Highway, 40 Sec. Reg. L.J.(2012) (discussing the fall of Enron and the subsequent accounting scandal, which “rocked the financial world”) 

[5]Id.

[6] See Fin. Accounting Standards Bd., Accounting Standards Codification 4, (Dec. 11, 2012), https://asc.fasb.org/imageRoot/80/34350180.pdf .

[7] Id.

[8] Fed. Accounting Standards Advising Bd., Our Mission,  F.A.S.A.B., (last visited Sept. 17, 2013)  www.fasab.gov/about/mission-objectives/(stating their mission as supporting public accountability. “[F]inancial reports, which include financial statements prepared in conformity with generally accepted accounting principles, are essential for public accountability and for an efficient and effective functioning of our democratic system of government.” “[T]hus, the Board plays a major role in fulfilling the government’s responsibility to be publicly accountable.” “[F]ederal financial reports should be useful in assessing (1) the government’s accountability and its efficiency and effectiveness, and (2) the economic, political, and social consequences, whether positive or negative, of the allocation and various uses of federal resources.”).

[9] Gov’t Accounting Standards Bd., Mission, Vision, and Core Values, G.A.S.B., (last visited Sept. 17, 2013)www.gasb.org/jsp/GASB/Page/GASBSectionPage&cid=1175804850352(stating that the goal of the F.A.S.B. is to provide “[g]reater accountability and well-informed decision making through excellence in public-sector financial reporting”).

The Glass-Steagall Act (“GSA”) commonly refers to Sections 16, 20, 21, and 32 of the Banking Act of 1933.[1] In passing the GSA, Congress hoped to “restore public confidence in the banking industry, ensure and maintain economic stability by prohibiting unsound and imprudent banking conditions, and remove potential conflicts of interest.”[2] Congress has created a distinction between commercial banking and investment banking through Sections 16 and 21 of the GSA legislation.[3] Section 20 bars Federal Reserve System member banks from affiliating with any organization “engaged principally” in the investment banking business.[4]  Section 32 aims to prevent “management interlocks”[5] between commercial banks and those engaged principally in investment banking activities by barring investment bank directors, officers, employees, and principals from holding the same position or duties at a Federal Reserve System member bank.[6] 

While Sections 16 and 21 seemingly erect a wall between commercial and investment banking, the GSA does not create an impenetrable barrier between these two activities.[7] In fact, the GSA permitted commercial banks to:

(i) buy and sell securities on the order of, and for the account of, their customers, (ii) underwrite obligations of the United States and the general obligations of states and political subdivisions thereof, (iii) purchase for their own accounts investment securities under regulations of the Comptroller of the Currency, and (iv) otherwise to act in accordance with their traditionally permitted trust powers.[8]

In 1999, the Gramm-Leach-Bliley Act (“GLBA”) was passed and repealed GSA.[9] The GLBA removed restrictions on underwriting by commercial banks and altogether repealed GSA Section 20, thereby permitting commercial banks to take part in investment banking activities through the creation of financial holding companies and subsidiaries.[10] It also repealed the GSA Section 32 prohibition of management interlocks between commercial and investment banks.[11]

[1] See Nikolas Theodore Nikas, Banking Law – Commercial Paper is a Security Under the Glass-Steagall Act – Securities Industry Association v. Board of Governors of the Federal Reserve System, 104 S. Ct. 2979 (1984), 1985 Ariz. St. L.J. 799, 799 n. 2..

[2]  Id. at 801.

[3] See id. at 802-03.

[4] See id. at 802 n. 13.

[5] See Ehud Ofer, Glass-Steagall: The American Nightmare That Became the Israeli Dream, 9 Fordham J. Corp. & Fin. L. 527, 544 (2004).

[6] See Jonathan Zubrow Cohen, The Mellon Bank Order: An Unjustifiable Expansion of Banking Powers, 8 Admin. L.J. Am. U. 335, 344 (1994).

[7] See Joseph Jude Norton, Up Against “The Wall”: Glass-Steagall and the Dilemma of a Deregulated (“Regulated”) Banking Environment, 42 Bus. Law. 327, 327 (1987).

[8] Id. at 327-28.

[9] See Jerry W. Markham, The Subprime Crisis – A Test Match for the Bankers: Glass-Steagall vs. Gramm-Leach-Bliley, 12 U. Pa. J. Bus. L. 1081, 1103 (2010).

[10]  See id. at 1103-04.

[11]  See supra note 5.

The term “hedge fund” generally refers to a private investment pool that is organized and operated to be exempt from the registration and regulatory requirements of the Securities Exchange Act of 1933 and the Investment Company Act of 1940.[1] Structured as private limited partnerships, limited liability companies, or business trusts,[2] hedge funds are managed by investment advisers who have a significant financial stake in their fund[3] and are compensated by management fees based on the performance of their fund.[4] To avoid registration and regulatory requirements, a hedge fund may not have more than 100 investors and must restrict its offerings to only highly sophisticated investors.[5] Further, a hedge fund may not offer its securities publicly or engage in public solicitation.[6]

The investment goals of hedge funds vary among funds, but many seek to limit risk and volatility while achieving an absolute positive return for investors.[7]Hedge funds originally used hedging as an investment strategy.[8][TM1]  Hedging involves the purchasing of a security and then taking an offsetting position in a related security so as to reduce the overall risk of loss on the investment as a whole.[9] While hedging is still an essential component of hedge funds, hedge funds now use a variety of strategies including arbitrage, leverage, short-selling, and the purchasing of complex derivatives.[10] “Hedge funds invest in equity and fixed income securities, currencies, over-the-counter derivatives, futures contracts, and other assets.”[11]

[1] See U.S. Sec. & Exchange Comm’n, Staff Report, Implications of the Growth of Hedge Funds, at viii (2003), available atwww.sec.gov/news/studies/hedgefunds0903.pdf.

[2] Id. at 9.

[3] Id. at viii, ix.

[4] See id. at ix.

[5] See id.

[6] See id. at x.

[7] Id. at viii.

[8] See Jacob Preiserowicz, The New Regulatory Regime for Hedge Funds: Has the SEC Gone Down the Wrong Path?, 11 Fordham J. Corp. & Fin. L. 807, 809 (2006).

[9] Id.

[10] Id. at 809-10.

[11] U.S. Sec. & Exchange Comm’n, Staff Report, supra note 1.

The transition from a closely held corporation to a publicly held corporation is termed an initial public offering[1]

Closely held corporations choose to have initial public offerings for many reasons.[2]  One reason that an initial public offering may be attractive to corporations is that it serves as a method of generating capital.[3]  Other reasons that corporations choose to go public include  increased prestige,[4]transferability of the corporation’s shares,[5] and publicity.[6]

Three groups regulate initial public offerings.[7]  The Securities Exchange Commission regulates initial public offerings through its Securities Act of 1933 and Securities Exchange Act of 1934.[8]  The Securities Act of 1933 governs “fraud, registration, and disclosure.”[9]  On the other hand, the Securities Exchange Act of 1934 regulates practices that manipulate the prices of shares on the market.[10]  The stock exchange that the corporation goes public on will have a variety of listing requirements by which the corporation will have to abide.[11]  Finally, the National Association of Securities Dealers governs the conduct of the underwriters that take part in the initial public offering process.[12]

One particularly difficult issue that concerns all parties involved in public offerings is pricing.[13]  In the context of the initial public offering, stocks are generally underpriced.[14]  Some authors opine that corporations are worried about failed public offerings to such an extent that they keep the prices low in order to ensure success.[15]  Others find this theory of underpricing dubious.[16]

[1] Christine Hurt, Moral Hazard and the Initial Public Offering, 25 Cardozo L. Rev. 711, 712 (2004); see James D. Cox & Thomas Lee Hazen, Corporations 23 (2d ed. 2003).  Closely held corporations are defined as “a corporation[s] with relatively few shareholders,” and “corporation[s] whose shares are not generally traded in securities markets.” Id. Publicly held corporations are “business corporation[s] . . . which have numerous shareholders . . . and whose shares (or some classes of shares) are traded on a national securities exchange or at least are traded regularly in the over-the-counter market maintained by securities dealers.” Id.

[2] See id. at 718.

[3] Jay R. Ritter & Ivo Welch, A Review of IPO Activity, Pricing, and Allocations, 57 J. Fin. 1795, 1796 (2002). To explain the benefits of this method, Ritter and Welch highlight various theories; all of these theories share the idea that the company can raise greater amounts of capital in comparison to what it would raise as a closely held corporation via an initial public offering.  Id. at 1798.

[4] Hurt, supra note 3, at 718.

[5] Id.

[6] Ritter et al., supra note 5, at 1796.

[7] Hurt, supra note 3, at 732.

[8] James D. Cox & Thomas Lee Hazen, The Law of Securities Regulation 255 (6th ed. 2009).

[9] Id.

[10] Id.

[11] Hurt, supra note 3, at 732.

[12] Id.

[13] Cox et al., supra note 10, at 262-63. This presents a difficult situation. On one hand, if one overprices and the stock price falls, investors may claim that they were mislead into purchasing the stock.  Id.  On the other hand, if the stock is underpriced, shareholders may claim that the corporation’s executives breached their duty to obtain as high a price for the shares as possible.  Id.

EME NOTE: (1) ) If it’s in the footnotes, it’s discussed in the text. (2) Please, no Greek mythology. Thank you.

[14] Id.

[15] Id.

[16] See Hurt, supra note 3, at 724-25 (indicating that underpricing is part of a scheme which simultaneously works illegally to the detriment of retail investors and the benefit of underwriters and market analysts).

Insider trading involves the purchase or sale of securities on the basis of material, non-public information, and is illegal in a variety of circumstances.[1]Congress addressed the appropriateness of insider trading in §§ 10(b) and 16(b) of the Securities Exchange Act of 1934.[2] Section 10(b) of the 1934 Act makes it unlawful for any person “to use or employ, in connection with the purchase or sale of any security . . . any manipulative or deceptive device or contrivance in contravention of such rules and regulations as the [SEC] may prescribe.”[3] To implement § 10(b), the SEC adopted Rule 10b-5, which broadly prohibits fraud in connection with the purchase or sale of any security.[4]

Under the traditional theory of insider trading, § 10(b) and Rule 10b-5 are violated when a corporate insider buys or sells a security in violation of a direct duty to that company and its shareholders.[5] Trading on such information qualifies as a deceptive device under § 10(b) because a relationship of trust and confidence exists between the shareholders of a corporation and those insiders who have obtained confidential information by reason of their position with that corporation.[6] Under the “misappropriation theory” of insider trading, § 10(b) and Rule 10b-5 are violated when a corporate outsider misappropriates confidential information in breach of a duty owed to the source of the information.[7] In either case, the individual must abstain from trading in the shares of the corporation unless the individual has first disclosed all material, nonpublic information to the party whom he or she owes a duty.[8]

Section 16(b) of the 1934 Act requires company insiders to return profits made on short-swing transactions that occur within any six-month period.[9] This rule prevents company insiders from taking unfair advantage of information obtained as a result of their relationship with an issuer.[10]

[1] Black's Law Dictionary 866 (9th ed. 2009).

[2] See Securities Exchange Act of 1934, 15 U.S.C. § 78 (2012).

[3] 15 U.S.C. § 78j(b).

[4] See 17 C.F.R. § 240.10b–5 (2011).

[5] See Chiarella v. United States, 445 U.S. 222, 228 (1980).

[6] Id.

[7] United States v. O'Hagan, 521 U.S. 642, 652 (1997).

[8] Cady, Roberts & Co., 40 S.E.C. 907, 912-13 (1961); see also SEC v. Texas Gulf Sulphur Co., 401 F.2d 833 (2d Cir. 1968).

[9] 15 U.S.C. § 78p(b).

[10] Id.

Limited Liability Company (LLC) is a non-corporate business entity governed by state law.[1]

The LLC is a combination of two traditional business structures, a corporation and a partnership.[2] However, the LLC offers certain advantages over each of these structures. One of the LLC’s primary advantages is that it is taxed as a partnership for federal tax purposes.[3] However, unlike a partnership, an LLC offers a corporate shield to protect its members’ and managers’ personal assets from creditors.[4] Further, unlike a corporation, an LLC is not double taxed because earnings and losses pass through the LLC to its members.[5]

LLCs are not without disadvantage. Members of LLCs are subject to self-employment taxes.[6] Additionally, LLC statutes lack comprehensive default rules.[7] States differ regarding the regulations they use to govern LLCs. Some states have adopted a uniform act,[8] while the majority of states have chosen to create their own individual regulations.[9]

[1] Taxation of Limited Liability Companies, I.R.S. Pub. 3402, 2 (Mar. 2010) (explaining how LLCs are taxed).

[2] See Howard M. Freidman, The Silent LLC Revolution—The Social Cost of Academic Neglect, 38 Creighton L. Rev. 35, 40-42 (2004-2005).

[3] I.R.S. supra note 1, at 2.

[4] Friedman, supra note 2, at 49.

[5] Id. at 49-50 (explaining double taxation as (1) corporations are taxed on their earnings, and (2) corporate shareholders are taxed on any after-tax earnings that pass through to them as dividends); I.R.C. § 11 (West 2006) (taxes paid on earnings).

[6] Id. at 53.

[7] See id. at 55.

[8] Legislative Fact Sheet – Limited Liability Company (Revised), Uniform Law Commission (2013) www.uniformlaws.org/LegislativeFactSheet.aspx (at least 10 states have adopted the uniform act).

[9] See id. (most states have not adopted the uniform act).

Market capitalization is an organization’s current share price multiplied by the number of shares outstanding.”[1]  “When expressed as a ratio to earnings, the resulting number is the firm’s price/earnings ratio or (P/E) multiple."[2]Under the Commodity Exchange Act, market capitalization of a security is determined by taking the average of the daily market capitalizations for the preceding six months.[3] 

Market capitalization is used as a basic method of valuation, anchored in the company’s actual performance.[4] Investors use market capitalization to divide the stock market into different categories according to market capitalization on an annual basis.[5] 

[1] Thomas P. Fitch, Dictionary of Banking Terms 282 (Irwin Kellner & Donald G. Simonson eds., 4th ed. 2000)

[2] Id.

[3] 17 C.F.R. § 41.11(a) (1) (clarifying Commodity Exchange Act, 7 U.S.C. § 1a(35)(B), 49 Stat. 1491 (2012)).

[4] VFB LLC v. Campbell Soup Co., 482 F.3d 624, 631 (3d Cir. 2007)

[5] See e.g., Russell U.S. Equity Indexes Construction and Methodology 3, Russell Investments, www.russell.com/indexes/documents/Methodology.pdf(last visited Sept. 20, 2013).

mutual fund is a jointly-owned financial instrument used for investing in stocks, bonds, money-market instruments, and other securities.[1] Since the Great Depression, mutual funds have become critical to the American financial system and are the investment tool of choice for many in our economic system.[2] Mutual funds, being open-ended funds, give the shareholders the compulsory ability to redeem their shares.[3]

There are several elements that distinguish a mutual fund from other intermediary investment mechanisms.[4] Investors pool their money to create an investment company. [5] This investment company then offers the investors shares that represent undivided ownership interest in the pool.[6] The management of the mutual fund, which is separate from its investors, invests and reinvests the pooled funds in securities.[7] The equal division of the net assets of the pool determines the value of each share.[8]

[1]  Invest Wisely: Mutual Funds, http://www.sec.gov/investor/pubs/inwmf.htm(last visited Oct. 9, 2013).

[2]  Invest Wisely: Mutual Funds, supra note 1.

[3]  United States v. Cartwright, 411 U.S. 546, 547 (1973).

[4]  Invest Wisely: Mutual Funds, supra note 1.

[5]  United States v. National Ass’n of Sec. Dealers, Inc., 422 U.S. 694, 698 (1975).

[6]  Lois Yurow ET AL., Mutual Fund Regulation and Compliance Handbook § 4:1 (west 2013).

[7] National Ass’n of Sec. Dealers, Inc., 422 U.S. at 699.

[8] Id. at 699.

A partnership is an “association of two or more persons to carry on as co-owners a business for profit . . . whether or not the persons intend to form a partnership.”[1] Thus, a business is a partnership if it has more than one owner and is formed without any action taken “to qualify it as a corporation or some other particular form of business structure.”[2] There is neither a requirement of filing papers nor any formal partnership agreement.[3][KU1] 

For tax purposes, a partnership is considered an aggregate of partners, so they pay the business’s taxes rather than paying on the partnership’s taxes.[4]This is also known as flow-through taxation, where the entity is viewed as separate from the owners.[5]

For business purposes, each partner is considered an agent of the partnership.[6] An act by any partner could bind the partnership if it is within the “ordinary course [of] the partnership business.”[7] If any partner acts outside the scope of the “ordinary course of the partnership business,” the partnership may still be bound by the act if it was authorized by the other partners.”[8][KU2] 

[1] Revised Unif. P’ship Act § 202(a) (2013-2014).

[2] David G. Epstein, Richard D. Freer, Michael J. Roberts & George B. Shepherd, Business Structures 65 (West, 3d ed. 2010).

[3] Id. (“Creating a partnership does not require that papers be filed in the public records. Partnership law does not even require that there be a written partnership agreement”).

[4] Id. at 63.

[5] Id.

[6] Revised Unif. P’ship Act § 301(1) (2013-2014).

[7] Id.

[8] Id. at §301(2).

A private equity fund is a type of limited partnership made up of investors and a private equity firm.[1] The investors provide capital,[2] and the private equity firm manages that capital.[3] Together, the investors and the firm own the fund. In this way, a private equity fund matches individuals with investment management expertise but limited funds with individuals that have disposable funds but little investment management expertise.[4] 

After a fund is created, the private equity firm strategically selects investments that fit within the fund’s investment portfolio.[5] Since the fund’s profits are wholly dependent on the success of its investments, a private equity fund generally carries more risk than other financial intermediaries that pay a fixed rate of return.[6] Further, because a private equity fund carries more risk, it tends to pay investors a higher rate of return than a fixed-rate intermediary.[7]  If an investment fails, the firm that managed the investment is indemnified against the investors, unless the firm’s conduct constituted gross negligence.[8]

[1]See Thomas H. Bell, Barrie B. Covit, Jason A. Herman, Glenn R. Sarno & Michael W. Wolitzer, Private Equity in 33 Jurisdictions Worldwide 108 (Casey Cogut ed. 2010).

[2] Id.

[3] Law Journal Press, Private Equity Funds: Business Structure and Operations § 4.01 (2000).

[4] See id.

[5] Id. at § 1.02.

[6] See id.

[7] See id.

[8] Id.

Private Securities Litigation Reform Act

The Private Securities Litigation Reform Act of 1995 ("PSLRA") amends both the Securities Act and Exchange Act, with the aim to limit frivolous securities lawsuits.[1] In Tellabs, Inc. v. Makor Issues & Rights, Ltd., Justice Ginsberg articulated the Supreme Court’s interpretation of the purpose of the PSLRA:

Private securities fraud actions, however, if not adequately contained, can be employed abusively to impose substantial costs on companies and individuals whose conduct conforms to the law. As a check against abusive litigation by private parties, Congress enacted the Private Securities Litigation Reform Act of 1995 (PSLRA), 109 Stat. 737.[2]

In a typical Rule 10b-5 claim, a plaintiff will commence the action by filing a complaint in federal court. The defendant will then file a motion to dismiss under Rule 12(b)(6) of the Federal Rules of Civil Procedure.[3] If the court determines that the facts alleged in the complaint are sufficient to state a Rule 10b-5 claim, the plaintiff becomes entitled to obtain discovery from the defendant.[4]

Prior to the PSLRA, plaintiffs could proceed with minimal evidence of fraud and use pretrial discovery to seek further proof.[5] This set a very low barrier to initiate litigation, which encouraged the filing of weak or entirely frivolous suits.[6]  The enactment and interpretation of the PSLRA raised the pleading standards, reducing the number of purportedly frivolous Rule 10b-5 lawsuits that survive motions to dismiss.[7]

[1] Ralph C. Ferrara and Philip S. Khinda, Recent Development Federal Agency Focus: Securities and Exchange Commission: SEC Enforcement Proceedings: Strategic Considerations For When the Agency Comes Calling, 51 Admin. L. Rev. 1143, 1183-84 (1999).

[2] Tellabs, Inc. v. Makor Issues & Rights, Ltd., 551 U.S. 308, 311 (2007) (citations omitted).

[3] See generally Fed. R. Civ. P. 12(b)(6).

[4] See generally 17 C.F.R. § 240.10b-5 (2013).

[5] See Tellabs, Inc. v. Makor Issues & Rights, Ltd., 551 U.S. 308, 311 (2007).

[6] See id.

[7] See generally Louie Loss, Joel Seligman & Troy Paredes, Fundamentals of Security Law 1765-89 (6th ed. 2011).

proxy statement is “[a]n informational document that accompanies a proxy solicitation and explains a proposed action (such as a merger) by the corporation.”[1] Proxy solicitation refers to a request issued to a shareholder in a corporation to allow another person to cast a vote for the shareholder.[2] The United States Securities and Exchange Commission (the “SEC”) regulates proxy statements and proxy solicitations.[3] The SEC sets forth the information that must be provided in a proxy statement and generally requires inclusion of a proxy statement with every proxy solicitation.[4] The SEC does not require a proxy statement when a proxy solicitation meets a specific set of guidelines.[5]

It is unlawful to make a misleading statement of material fact in a proxy statement or proxy solicitation.[6] Determining whether or not a statement is material requires a court to perform an objective test that evaluates the significance a reasonable shareholder would attach to the statement in deciding how to vote.[7] To find a violation, it is not necessary to establish that a reasonable shareholder would have changed their vote absent the misleading statement.[8] Rather, the misleading statement will be deemed material if “disclosure of the omitted fact would have been viewed by the reasonable investor as having significantly altered the ‘total mix’ of information made available.”[9]

[1] Black’s Law Dictionary 1347 (9th ed. 2009).

[2] See Id. at 1346.

[3] See 17 C.F.R. § 240.14a (2013).

[4] See 17 C.F.R. § 240.14a-3(a).

[5] See 17 C.F.R. § 240.14a-2.

[6] See 17 C.F.R.. § 240.14a-9(a).

[7] See TSC Industries, Inc. v. Northway, Inc., 426 U.S. 438, 445 (1976).

[8] See id. at 449.

[9] Id. at 449-450.

registration statement is a document that a company must file with the U.S. Securities and Exchange Commission (“SEC”) before it can proceed with a public offering.[1]   The registration statement provides essential facts about the filer, including information about its earnings, distributions, capital structure, and the company’s future.[2] A registration statement generally becomes effective 20 days after it has been filed with the SEC.[3] Once the registration statement becomes effective, the company may begin to sell its securities.[4] The registration statement must also contain the information and be accompanied by the documents specified in Schedule A of 15 U.S.C. § 77aa.[5]

Not all companies that sell securities must file a registration statement: the Securities Act of 1933 allows the SEC to provide for exemptions to the registration statement requirement “as it determines consistent with the public interest and the protection of investors.”[6] The duty of the legal counsel is to ascertain whether costs of filing registration statement can be avoided by relying on an exemption.[7]

[1] See 15 U.S.C. § 77e(a),(c) (2012); James D. Cox & Thomas Lee Hazen, 4 Treatise on the Law of Corporations § 27:11 (3d ed.).

[2] See Cox & Hazen, supra note 1.

[3] 15 U.S.C. § 77h (2012).

[4] See 15 U.S.C. § 77e(a) (2012) (“Unless a registration statement is in effect as to a security, it shall be unlawful for any person, directly or indirectly … to sell such”).

[5] 15 U.S.C. § 77g(a)(1) (2012).

[6] 15 U.S.C. § 77g(b)(2) (2012).

[7] See Cox, Law of Corporations, supra note 1

Rule 10b-5 was promulgated under the broad rule making power granted to the Securities and Exchange Commission by the Security Exchange Act of 1934.[1]  It was written to prevent fraud and abuse in the securities market by promoting free and open markets.[2]  The rule prohibits the following practices in the purchase and sale of securities: “(a) to …defraud, (b) to make any untrue statement of a material fact or to omit to state a material fact necessary in order to make the statements made … not misleading, or (c) to engage in any act … which operates or would operate as a fraud or deceit upon any person.”[3] Although the rule does not define the term material fact, the courts have defined it as information that a reasonable shareholder might with a substantial likelihood find important.[4] 

The prohibition on using deceptive or fraudulent practices or devices in the purchase and sale of securities has been used to extend 10b-5 to cover insider trading.[5] In cases of insider trading, Rule 10b-5 requires “that when potential securities traders have obtained the material information in such a way as to subject them to Rule 10b–5’s reach, they must either abstain from trading or disclose the information prior to trading.”[6]

[1] James D. Cox and Thomas Lee Hazen, Treatise on the Law of Corporations § 12:9 (2012).

[2] Arnold S. Jacobs, Disclosure & Remedies Under the Securities Laws § 15.1 (2013).

[3] 17 C.F.R.  § 240.10b-5.

[4] See e.g., TSC Indus., Inc. v. Northway, Inc., 426 U.S. 438, 449 (1976). See also Cox & Hazensupra note 1.

[5] Thomas Lee Hazen, Treatise on the Law of Securities Regulations § 12.17 (2013) (“The securities laws do not expressly prohibit trading on the basis of nonpublic information. Instead, the prohibition has been crafted out of the Securities Exchange Act's antifraud provisions found in section 10(b) and SEC Rule 10b–5”).

[6] Id.

The U.S. Securities and Exchange Commission, or SEC, was created in 1934 as a result of the Securities Exchange Act of 1934.[1] The Act was a response to the Great Depression.[2] [KU1] The SEC consists of five presidentially-appointed commissioners, each of whom is appointed for a five-year term, on a staggered basis.[3] Additionally, only three commissioners can be of the same political party.[4] The SEC is headquartered in Washington, D.C., and is split into five divisions, consisting of 23 offices in total.[5] The five commissioners form the Commission, whose task is to:

1.     “Interpret and enforce federal securities laws; 2.     Issue new rules and amend existing rules; 3.     Oversee the inspection of securities firms, brokers, investment advisers, and ratings agencies; 4.     Oversee private regulatory organizations in the securities, accounting, and auditing fields; and 5.     Coordinate U.S. securities regulation with federal, state, and foreign authorities.”[6]

The five divisions of the SEC are the Division of Corporation Finance, Division of Trading and Markets, Division of Investment Management, Division of Enforcement, and Division of Economic and Risk Analysis.[7] The Division of Corporate Finance is largely tasked with reviewing and overseeing documents that corporations file to the public with pertinent investment information.[8] They are reviewed for both accuracy and completeness. The responsibilities for the Division of Trading and Markets include oversight of markets, looking for lapses in fairness and efficiency.[9]

The Division of Trading and Markets also oversees market participants and oversees the Securities Investor Protection Corporation, a public safeguard against brokerage houses.[10] The Division of Investment Management helps to protect investors and promotes economic growth by overseeing and regulating the investment management industry.[11] Next, the Division of Enforcement is charged with investigating, enforcing, and prosecuting any breaches to the fullest extent of the law.[12] Finally, the Division of Economic and Risk Analysis encourages fairness by protecting investors and conducting economic analyses on the markets with respect to market policy development.[13]


[1] The U.S. Sec. & Exch. Comm’n, The Investor’s Advocate: How the SEC Protects Investors, Maintains Market Integrity, and Facilitates Capital Formation, sec.gov, www.sec.gov/about/whatwedo.shtml (last modified Jun. 10, 2013).

[2] Id.

[3] Id.

[4] Id.

[5] Id.

[6] Id.

[7] Id.

[8] Id.

[9] Id.

[10] Id.

[11] Id.

[12] Id.

[13] Id

The Securities Act of 1933 regulates the offer and sale of securities to the public.[1] The Act’s regulations are meant to ensure that public investors are able to purchase securities at an accurate market price.[2] The Act promotes accurate pricing by ensuring that investors are able to access reliable information.[3]  To this end, the Act requires companies to disclose relevant financial information and imposes liability on companies that disclose false or misleading information.[1]

Under the Act, every company that offers or sells its securities to the public must disclose all “information that a reasonable investor might consider important when making an investment decision.”[4] A company discloses this information in a detailed registration statement, which is filed with the Securities and Exchange Commission and made available to the public.[5]

The Act is enforced when either 1) the Securities and Exchange Commission brings a criminal suit against a company that provides false or misleading information,[6] or 2) an individual investor may files a civil action to recoup losses caused by the disclosure of false or misleading information.[7]

[1] See Marc  I. Steinberg & Brent A. Kirby, The Assault on Section 11 of the Securities Act: A Study in Judicial Activism, 63 Rutgers L. Rev. 1, 4 (2010).

[2] Note, Disclosure of Future-Oriented Information Under the Securities Laws,88 Yale L.J. 338, 339-41 (1978) [hereinafter Securities Laws].

[3] See Steinberg et al., supra note 1.

[4] Affiliated Ute Citizens of Utah v. U.S., 406 U.S. 128, 153-54 (1972).

[5] See 15 U.S.C. § 77b(a)(8)-(10). 

[6] Id. at § 77t.

[7] Id. at § 77k.

The Securities Exchange Act of 1934 [1](“the Exchange Act”) primarily protects investors in the secondary market for securities, i.e. the market for securities after their initial issuance by the corporation.[2] The Exchange Act protects investors through[3]: (1) forcing mandatory disclosures on corporations to inform potential investors (through 10K, 10Q, and 8K filings);[4] (2) regulation of participants in the securities market, such as securities exchanges and broker-dealers[5], (3) requiring registration of all securities traded on securities exchange[6]; and (4) prohibiting fraudulent or deceitful trading practices in securities trade[7]. The Exchange Act also creates the Securities and Exchange Commission (SEC) and grants it the power to enforce the Act.[8]

[1] Securities Exchange Act of 1934, Pub. L. No.  73–291, 48 Stat. 881 (1934) [hereinafter “Exchange Act”] (codified at 15 U.S.C. § 78a et seq.).

[2] Securities Exchange Act of 1934 (the Exchange Act), Legal Information Institute, www.law.cornell.edu/wex/securities_exchange_act_of_1934 (last visited September 19, 2013).

[3] See generally id.

[4] See Exchange Act, supra note 1, §§ 13 a, 14 (a)­–(c).   

[5] See Exchange Act, supra note 1, §§ 5–6.

[6] See Exchange Act, supra note 1, § 12 (a)–(b).

[7] See Exchange Act, supra note 1, § 12 (b); 17 C.F.R. § 240.10b-5.

[8] See Exchange Act, supra note 1, § 4.

Securities Fraud (including Rule 10b-5) describes a variety of distinct causes of action,[1] both civil and criminal, for fraudulent activities, “all of which involve the deception of investors or the manipulation of financial markets.”[2] It includes private actions relating to the purchase or sale of securities that arise from a knowing material misrepresentation or omission that results in a loss.[3]

Private actions are rooted in Section 10(b) of the Securities Exchange Act of 1934, which forbids the use of any manipulative or deceptive information provided in connection with the purchase or sale of a security.[4]  Section 10(b) is enforced by the U.S. Security and Exchange Commission’s Rule 10b-5. Under Rule 10b-5, it is unlawful to:

(a) Employ any device, scheme, or artifice to defraud,

(b) Make any untrue statement of a material fact or to omit to state a material fact necessary in order to   make the statements made ... not misleading, or

(c) Engage in any act, practice, or course of business which operates or would operate as a fraud or deceit upon any person, in connection with the purchase or sale of any security.[5]

This list is not exhaustive, and the activities prosecuted as securities fraud are subject to a developing definition based on a “case-by-case evolution of statutory standards.”[6]

[1] In re Initial Pub. Offering Sec. Litig., 399 F. Supp. 2d 298, 303 (S.D.N.Y. 2005), aff'd sub nom. Tenney v. Credit Suisse First Boston Corp., Inc., 05-3430-CV, 2006 WL 1423785 (2d Cir. May 19, 2006).

[2] Securities Fraud Awareness & Prevention Tips, FBI.gov (last visited September 8, 2013) www.fbi.gov/stats-services/publications/securities-fraud.

[3] Tellabs, Inc. v. Makor Issues & Rights, Ltd., 551 U.S. 308, 319 (2007) (explaining that a private plaintiff must prove that the defendant acted with an “intent to deceive, manipulate, or defraud”); Amgen Inc. v. Connecticut Ret. Plans & Trust Funds, 133 S. Ct. 1184, 1206 (2013).

[4] Tellabs, 551 U.S. at 318.

[5] Id. at 1193 n.2. Examples of securities fraud include high yield investment fraud, Ponzi schemes, pyramid schemes, advanced fee schemes, foreign currency fraud, broker embezzlement, hedge fund related fraud, and late day trading. Securities Fraud Awareness & Prevention Tips, supra note 2.

[6] Black & Co., Inc, 1984 WL 906627 at *20, Admin. Proc. File No. 3-3460 (S.E.C. July 12, 1974) (“[T]he definition of securities fraud . . . seems to take form in a seemingly infinite number of factual variants, mutations, and permutations.”).

shareholder is a person or entity in whose name shares are registered in the records of a corporation.[1]  A shareholder may own all or part of the shares of proprietary interests in a corporation.[2]  The corporation may make distributions to shareholders subject to restrictions set forth in the articles of incorporation.[3] The class of shares issued to shareholders also determines the rights shareholders have within the corporation and their proprietary interests.[4]  Notwithstanding a shareholder’s ownership interests in a corporation, shareholders and corporations are different entities.[5] Shareholders are not personally liable for the acts or debt of the corporation unless a corporation is deemed to be a mere “instrumentality” or “alter-ego” of a majority shareholder.[6]

[1] See Model Bus. Corp. Act § 1.40 (21) (1984).

[2] See id. at § 1.40 (22).

[3] See id. at §6.40 (a).  In addition to making distributions subject to the articles of incorporation, subsection (a) of §6.40 of the Model Business Corporations Act states that such distributions also are subject to the restrictions set forth in subsection (c).  Id. Subsection (c) states that:

No distribution may be made if, after giving it effect: (1) the corporation would not be able to pay its debts as they become due in the usual course of business; or (2)  the corporation’s total assets would be less than the sum of its total liabilities plus (unless the articles of incorporation permit otherwise) the amount that would be needed, if the corporation were to be dissolved at the time of the distribution, to satisfy the preferential rights upon dissolution of shareholders whose preferential rights are superior to those receiving the distribution.

Id. at §6.40 (c).

[4] See e.g., id. at § 6.23(b).

[5] Steven G. Marget, Shareholder Liability – Lakota Girl Scout Council, Inc. v. Havey Fund-Raising Management, Inc. – A Single Factor Test?, 3 J. Corp L. 219, 219 (1977-78).

[6] Id. See also Model Bus. Corp. Act § 6.22.

Vicarious liability, sometimes referred to as respondeat superior,[1] is the “[l]iability that a supervisory party bears for the actionable conduct of a subordinate or associate based on the relationship between the two parties.”[2]  Vicarious liability is “essentially a form of strict liability” because it puts liability on the non-acting corporation for the conduct of its employees and agents.[3]  This is of particular importance to corporations because “[they] can only act through their employees or agents.”[4]  Vicarious liability is also of great importance to potential plaintiffs who are in search of “deep pockets.”[5]

When determining whether a corporation is vicariously liable for the criminal acts of its employees or agents, courts look to see whether their conduct was within the scope of employment or agency and whether they intended to benefit the corporation.[6]  “[I]f the employee or agent acts only in his or her own self-interest, vicarious criminal liability would not be imposed upon the corporation.”[7]

[1] Maria M. Romani, Civil Rico and Vicarious Corporate Liability: Shrinking Civil Rico Back to Its Originally Intended Congressional Size, 15 Ohio N.U. L. Rev. 695, 698 (1988) (citing W. Keeton Et Al., Prosser And Keeton On The Law Of Torts § 69 (5th ed. 1984) (“Vicarious liability is often referred to by its Latin name of respondeat superior,” and the two terms are sometimes used interchangeably).

[2] Black's Law Dictionary 18 (9th ed. 2009).

[3] Romani, supra note 1, at 698. See § Burlington Industries Inc. v. Ellerth, 524 U.S 742, 744 (1998) (discussing how employee’s or agent’s conduct must have been “in the scope of their authority or employment”).

[4] Romani, supra note 1, at 698-99, (emphasis added) (internal quotation marks omitted) (“Corporations as employers or principals may incur vicarious liability for the torts committed by their employees or agents.  As an employer, corporations are civilly liable for the tortious acts of their employees that are committed within the scope of their employment.”).

[5] Id. at 697 (internal quotation marks omitted) (“[V]icarious liability is often the only way to ensure that a deep-pocket defendant will be joined in the lawsuit.”).

[6] See U.S. v. Cincotta689 F.2d 238, 241-42 (1st Cir. 1982).

[7] Romani, supra note 1 at 700.