cpa notes chapter 29-32,34,44

7/23/2019 CPA Notes Chapter 29-32,34,44

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CPA LAW EXAM III Notes

Chapter 29: Management of the Corporate Business

Introduction: SHs are known as the owners of the corp, they affect the way business is run thru their power to electdirectors and amend articles. They do not have power to make mgmt decisions. No right to instruct the directors/officerson operating decisions. irectors make the day!to!day operating decisions to the officers. "#$% re&uire SHs to getapproval for special actions 'merger, sale/lease of substantially all assets, dissolution( from the #).

he Board of !irectors

Po"ers # !uties* irectors tend to ratify mgmt decisions made by top e+ecs rather than

to take the initiative in making the decisions. "#$% now says* %ll corp powers shall be e+ercised by orunder the authority of, and the business and affairs of a corp shall be managed under the direction of, a #).-"#$% used to say the business of the corp shall be managed by a #)-.

$enera% Po"ers of the Board: "#$% permits the board to take the following actions by itself*

. eclaring a dividend.. 0stablishing the price for the sale of shares1. 0lecting and removing officers2. 3illing vacancies on the #)

4. Selling, leasing, and mortgaging assets of the corp outside normal course of business.

o Actions &e'uiring Board Initiati(e* 5nitiative process re&uires that the #) propose the

matter to SHs, who then must approve the actions. 6e&uired for fundamental changes in the corp*. %mendment of articles of incorp. "erger of the corp1. Sale of all or substantially all assets2. 7oluntary dissolution of the corp.

)n%ine Communications* irectors can now legally communicate official business by email

E%ectronic Communications- 5ncludes form of comm that dont involve the physical transmission ofpaper if the comm. $reates a record that can be retained* retrie(ed* or re(ie"edby the recipient and can

be reproduced in paper form.+ #) meetings cant take place electronically! 8ermits director resignations to be transmitted electronically.! irector actions taken by unanimous consent may be taken electronically.

Po"ers # &ights of a !irector as an Indi(idua%* irectors are N)T agents of the corp

by virtue of that office. They have power to act for the corp only as part of the board, not as individuals. %director can become an agent if she is also serving as an employee of the corp.

o Director has right to inspect the corp books & records. Necessary to carrying out the directors duty of

overseeing mgmt. 6ight to inspect can be denied where 5 can be shown that the director has an interestthat conflicts w/ that of the corp.

E%ection of !irectorsNum,er of !irectors* "#$% re&uires only one, some states re&uire 1. "#$% allows the 9 of directors to be fi+ed in

either the articles or bylaws. Not necessary to amend articles when a director dies or resigns and the directors arent readyto nominate a successor.-ua%ifications* % few states re&uire directors to be SHs, some re&uire that a certain percentage of directors be citi:ens of

the state of incorp or of the ;S.


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annual meeting unless there are vacancies. Staggered terms are to ensure that e+perienced directors remain on board?however, they are usually adopted to make a corp takeover more difficult..acancies* $an be filled only by a vote of the SHs unless the state statute, the articles, or bylaws give this power to the

board itself. "#$% permits a ma@ority of the remaining directors, even tho less than a &uorum, to elected directors toserve out une+pired terms. 8ermits the board to increase the si:e of the board then to elect a director to the vacancycreated.

&emo(a% of !irectors: irector may not be removed w/out cause unless this is permitted

by statute or by articles or bylaws adopted prior to the directors election. "#$% permits SHs to removedirectors w/ or w/out cause. % director who has failed to/unable to attend and participate in directors meetingsor who has acted contrary to the interests of the corp 'mismgmt, conflict of interest( can be removed for cause.SHs can remove a director for cause at any time even though the power of removal has been given by thearticles or bylaws to directors. #efore being removed for cause, a director must be given notice and a hearing.

!irectors/ Meetings

o 0re'uenc1* ;sually schedule regular meetings. Aarge corps meet monthly or &uarterly. Small corps where

directors are active in business meet formally @ust once a year. The directors other meetings are informal w/ no minuteskept.

o Notice* 6easonable notice must be given for special meetings. 5f all directors attend a meeting, this cures any

defect in or failure to give notice. % director who has not received a proper notice may attend solely to complain of the

notice, and he would not be held to have been in attendance. irectors may also cure a defect in the notice by signing awaiving notice before or at meeting.o 0orma%it1* "#$% permits directors to act w/out a meeting if all directors consent in writing to the action taken,

and permits a director to attend a meeting thru telephone. )nly re&uirement is directors must be able to hear one anothersimultaneously.

o -uorum* 0ach director only has one vote, regardless of his shareholdings. %ctions taken by a board are

ineffective unless a &uorum is present 'ma@ority of the 9 of directors fi+ed by the articles/bylaws(. %rticles may set&uorum at a higher figure.

Compensation of !irectors* "#$% permits directors to fi+ their compensation unless this is prohibited by articles of

incorp. )utside directors 'not employees of corp( are paid rather modest fees even in the largest corps, but fees are risingrapidly.

Compensation committeesare now e+pected to practice real oversight, including meeting w/compensation consultants and their firms H6 dept independent of top mgmt.

)fficers of the Corp

Po"ers* "#$% provides that a corp shall have a president, > 78, a secretary, and

treasurer. %ny > offices may be held by the same person e+cept the offices of president and secretary'permits dual signatures on corp docs(.

President of Chairman* 8ower of officers to bind the corp on contracts is the same of

any agent. 5n addition to e+press authority, they have implied and apparent authority, and certain officers'president and $0)( may have e+ officio authority 'authority by virtue of their offices(. 8resident or chairmanhas no power to bind the corp solely bc of his position. )fficer liable on losses if he acts beyond his authority.

.ice President:No authority by virtue of that office. However, if title indicates the

person is the principal officer of some area of the business, he has considerable implied authority 'fore+ample, the 78 of mktg has implied authority to do those acts normally done by a manager of sales(.

Corp ecretar1: aka clerk. Beeps the minutes of meetings of SHs and directors and

other general corp records 'stockholder records(. )ffice gives the secretary no authority to bind the corp oncontracts, but there is a presumption that a doc to which the secretary has affi+ed the corp seal is properlyauthori:ed.

reasurer: 5n charge of funds. Has power to pay out corp funds for proper purposes and

receives pmts to the corp. #inds the corp on receipts, checks, and endorsements. oes not have authority byvirtue of the office alone to borrow C or issue negotiable instruments.


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!uties of !irectors and )fficers: ;nlike directors, the corp officers are agents of the corp. The directors share w/ theofficers the same fiduciary duties that an agent owes the principal. 3iduciary duties include*

345 !ut1 to act "6in one/s authorit1 and "6in the po"ers of the corp: %uthoritygiven by statute, articles, bylaws. irectors/officers may be liable to corp if it is damaged by an acte+ceeding authority or outside scope of corps authority. 5f they enter an u%tra (irestr+n, @ustifiablebelieving it to be w/in scop of corps business, they arent held liable.

&atification: a corp may ratify an unauthori:ed act by officers/agents thru a resolution of the

#) or the SHs. 5mplied from acceptance of benefits from unauthori:ed act. 6eleasesofficer/director from liability.

!ut1 to act di%igent%1 and "6 due care in conducting the affairs of the corp:

Prudent Person tandard: "#$% re&uires that a director/officer discharge his duties

w/ such care as an ordinarily prudent person in a like position would use under similarcircumstances- 'common sense, practical wisdom, and informed @udgment(. Dreater actual&ualifications of individual E greater level of duty.

)fficer6!irector "i%% ha(e discharged her dut1 of care if she acts:

345 5n good faith245 %s would an ordinary prudent person under like circumstances.745 ;nder reasonable belief she is acting in best interests of corp.

"#$% permits directors/officers to rely on opinions, reports, and statements ofpersons who reasonably appear to be competent and reliable. uty of care re&uires making areasonable investigation before any corp decision.

Business 8udgment &u%e: irectors/officers arent liable for mere errors of

@udgment when they act w/ care F good faith 'honest mistakes in @udgment(.Must meet 7 re'uirements in arri(ing at their decision:

345 An Informed !ecision

245 No Conf%ict of Interest

745 &ationa% Basis* decision cant be manifestly unreasonable- or gross negligence.

!ea% Protection !e(ices adopted by the board to protect the original merger tr+n

must withstand @udicial scrutiny under an enhanced std of review. implicate345 Gudicial determination regarding the ade&uacy of the decision!making process employed by

the directors, including the info on which the directors based decisions.245 Gudicial e+amination of the reasonableness of the directors action in light of the

circumstances.745 irectors have burden of proving they were ade&uately informed and acted reasonably.

Legis%ati(e &esponses to Increased !irector Lia,i%it1* Aegislations 'amendment(

to limit directors liability for breach of the duty of care*Charter )ption tatutes: authori:es any corp to adopt a specific amendment to its articles of incorp that removes breach

of duty as a cause of action for monetary damages against directors. #) and SHs would have to approve limitation, butofficers/directors still would be liable for intentional misconduct, failure to act in good faith, self!interest, knowingviolations, breach of loyalty of duty.

o e%f+Eecuting tatutes: irectors will have no liability for breach of the duty of care in

the absence of willful misconduct or recklessness. %utomatically effective, no board orSH action is necessary to trigger their applicability.

Cap )n Monetar1 !amages tatute: %dopted by 7%. The ma+ liability that may be imposed on directors is the greater

of C, or the amt of cash compensation that the director received from the corp during the previous months. $anamend articles to reduce the cap, but cant increase it.

1.( !ut1 to act "6 %o1a%t1 and good faith for ,enefit of corp: "ust act in bestinterest of corp, breach this duty if they try to profit personally at e+pense of the corp.

e%f+!ea%ing* % director/officer must fully disclose his interest if he enters a contract

w/ the corp. $ontracts only voidable if unfair to corp. %fter full disclosure, the disinterestedmembers of the board or the SHs themselves must approve the tr+n. %pproval doesnt


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automatically relieve the self!dealing director/officer from liability to corp. "#$% says theinitial burden of proving the fairness of the tr+n lies w/ the self!dealing director/officer. %fterproper approval from board/SHs, the burden of establishing unfairness shifts to corp.

surping Corporate )pportunities* irectors/officers cant usurp 'sei:e( a corp

opportunity. '0+* irectors cant buy the right to sell a product that would fit into the corpsline of goods. 5f the corp is financially unable to pursue the opportunity, a director or officermay take it(. 7 E%ements must ,e met to ha(e usurped an opportunit1:

.( )pportunity must have come to them in their corp capacity..( )pportunity must be related to the corp business.1.( $orp must have been able to take advantage of the opportunity.

IThe director may still avoid liabilityif she can show that the corp waived its rights to the opportunity'director offered the opportunity in full disclosure to the corp but the corp re@ected it( "ay be impliedwaiver if corp knew of opportunity and failed to act timely.

0ree;e+)uts* )ppression* # Bad 0aith*

0ree;e+)ut* )ccurs when the corp is merged w/ a newly formed corp under terms by which the minority SHs receive

cash or other securities for their shares, rather an receiving stock in the new corp. ;su involve close corps.)ppression* 3re&uently occurs when the ma@ority SHs refuse to pay dividends even though the corp is able to.

+ )thers claim that the corp wont hire minority SHs while unreasonably high salaries have

been paid to controlling SHs and their friends.+ )thers involve purchases by or sales of assets to controlling SHs where the price is said tobe unfair.

+ "inority SHs only win such suits where the acts of directors have been clearly been in ,adfaithor abused discretion given to directors under @udgment rule.

rading on Inside Info* 3ederal S0$ laws prohibit insiders 'those

w/ confidential material info about corp( from buying or selling its stock. 7iolates fiduciaryduties.

!irectors/ &ight to !issent* % director who agrees to the actions of

the #) may be held liable if the board has failed to abide by its duties to the corp. %nydirector who attends a #) meeting is held to have assented to the boards actions unless he

specifically dissents. ;nder "#$%, a director will not have dissented unless he refused tovote for the proposed course of action and makes this dissent clear to the other boardmembers by having it appear in the minutes or by giving a written notice to the chairman orsecretary immediately following the meeting.

Lia,i%it1 for orts # Crimes

Corporate Lia,i%it1

ort Lia,i%it1* $orp is liable for all torts committed by its employees while acting in the course of and w/in the scope of

their employment, in some cases even when the corp has instructed the employee to avoid the act 'respondeat superior(.Crimes* "any criminal statutes clearly are intended to apply to corps 'securities act, antitrust laws, employment

relationship laws(. Tradition view* corp couldnt be held guilty of a crime involving intent. Today, courts are likely to findcriminal liability when a crime is committed, re&uested, or authori:ed by the #), officer, of high!level mgr.

Lia,i%it1 of )fficers and !irectors

orts: "odern courts much more willing to find negligence on the part of corp directors/officers. Jhere corp activities

cause in@ury/economic damage to others, the officer/director in charge may be held liable. )fficer/director may be heldliable for torts of employees of corp if he authori:es/participates in the commission of the tort.Crimes: irectors/officers may be held criminally liable for failing in their supervisory duties, re&uested, authori:ed, or

assisted in commission of crime and when the officer*.( Bnew of or should have known of the illegal conduct and.( 3ailed to take reasonable measures to prevent it.


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Indemnification* To encourage people to become officers/directors, corps often pays them for e+penses in

defending/settling a suit or criminal charge brought against them.! Mandator1* irector/officer prevails on suit or guilty but in good faith w/ pree+istingindemnification agreement.! .o%untar1 Indemnification* Jhen the officer/director is found guilty, he still may beindemnified if he acted in good faith, believed he was acting in corp interest, unaware action wasillegal, and disinterested board, legal counsel, or SHs agree to indemnify.! Impermissi,%e* )fficer/director who acted in bad faithor liable to corpmay not beindemnified under any circumstances, including damages sustained as a result of violating FedSEC laws.

Chapter 7* 5f a corp only has one class of stock, its common. 5f there is more than one, common SHs beathe ma@or risks and benefit most from success by receiving whats left over after the other classes have beesatisfied 'for both dividends and net assets on li&uidation(. ;sually carries voting rights, but may have mothan one class.

o Preferred toc>* %ny stock that has preference over another class of stock. "ay be made convertible into

common stock, sometimes given voting rights 'right to vote usually only granted if dividends due are notpaid( 'preference in dividends(

"ay be redeemedeven if the SHs dont want to sell. 'paid off and canceled by corp if articles

permitand redemption price must be stated(.

Consideration for hares* "oney, property, or services already performed for corp. #)

has authority to decide what is proper amt and form of consideration. $orp statutes may place limitations ondiscretion of #) to protect SHs.o )%d MBCA Approach* '"ost states(. The promoters preincorp services arent considered proper

considerations b/c the services werent technically rendered to the corp since it wasnt in e+istence at thetime. 8romissory notes or pledges of future service dont count either 'may overstate value of corp sincethey may never be performed(.

o &e(ised MBCA Approach* 8ermits promises of future services and promissory notes tobe e+changed foshares since they do have value to the corp 'value may not be as great as value of services already renderedue to risk of non!performance(.%lso permits corp to issue shares to promoters in preincop efforts b/c thecorp benefited from services.

.a%ue of hares

Par .a%ue* %rbitrary amount assigned to value the shares of stock.tated .a%ue* 5f stock has no par value, the #) may assign a stated value.

o tated Capita%* $alculated as ' 9 of outstanding shares( K 'the par or stated value of each share(. 8ar value and

stated value reflect the minimum amt of consideration the shares can be issued. 5f shares were issued for lethan par/stated value, stated capital would e+aggerate actual value of corp. #) and purchasers of shares liable to the corp when shares have been issued for less than par value.

oCapita% urp%us* Jhen shares sell for more than their par/stated value. #) must, in good faith, determine the am

of appropriate consideration 'duty to receive the fair value of the stock(. $alculated as '%mount received pshare "5N;S par value( K '9 shares outstanding(.

)ptions* Warrants* # &ights*


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o )ptions* "#$% allows directors to issue options to purchase shares in connection w/ other securities or

issued to employees as an incentive to increase profitability to ma+imi:e the mkt value. SH approval isre&uired.

o Warrants* )ptions represented by certificates. Sometimes part of a unit being sold.

&ight* %pplies to short!term and often nonnegotiable options. Dives present security hold

a right to subscribe to some proportional &uantity of the same/different security of a corp.)ften given in connection w/ a preemptive right re&uirement.

reasur1 toc>* % corp may buy its securities from any willing seller, doesnt need to state specificauthority in its articles. "#$% permits this only out of unrestricted earning surp%us'when a corp retainall/part of its operating profit rather than paying out dividends(.! $apital surplus may only be used on t /1 vote of SHs.! $apital surplus arises when sales of shares is above par value.! Treasury shares cant be voted in elections.! Treasury shares can be resold w/out regard to par value/original price.

!e,t ecurities* #orrowing CC for operations.Power is inherent, need no

appear in articles. They do not transfer an ownership interest in the corp. $reates a debtor!creditor relationship$orp/debtor obligated to pay periodic interest.o Notes* Short!term debt instruments 'less than 4 yrs(. Secured 'creditor may force the sale of collateral if d

isnt paid according to terms or unsecured(.o !e,entures* Aong!term unsecured debt instruments. $an be for 1> years.

Indenture* % contract protecting rights of debenture holder 'defines what acts constitute default b

the corp and stipulates rights of holder on default.o Bonds* Aong!term, secured debt securites. Denerally have indentures. Security may be real 'building( or

personal property 'machinery, raw materials, accounts due from customers(. #ondholders and secured notholders have priority to assets securing the debt.

Becoming a hareho%der 'SHs mostly interested in the right to share profits, even tho they have many rights(.

0unctions of =/s* 3ew functions, e+ercise little influence.

Principa% function* 0lection of SHs, but in large corps SHs vote following the recommendations of mgm

%lso reuired to approve unusual or e!traordinary corp tr!ns'merger, sale of substantially all corp assets

voluntary dissolution(. 3avorable vote necessary to amend the corp articles or stock option plans for corp officers/managers.

%pproval of loans to officers by corporation.

Means of Ac'uiring toc>

o Subscribing to shares in a new corpbeing formed. ;sually treated as offers until incorporation is

completed. Such subscriptions irrevocable for si+ months. %cceptance occurs by action of #) afterincorporation, subscriber comes SH.

o Subscribing to shares that are being issued by e!isting corp. Treated as an offer, corp must accept. 5ssuing Stock*

"aking of the subscription contract. $ertificate cant be issued til shares are paid in full.

o #uy newly issued shares that have been underwrittenby an investment banker and sold thru

Stockbroker. 'underwrite* agrees to mkt it to investors and usu guarantees to sell entire issue at

agreed!on price(.oMost common* buying previously issued shares from former owner 'directly or thru broker(.

hareho%der/s Meeting

Annua% Meeting* 6e&uired by all states e+cept elaware 'which can use a mail ballot instead(. "ain purpose is the

election of directors. %sk the SHs to approve selection of public auditors, or e+ecutive stock option/profitsharing plan, or amendment to articles of incorp. $0) or other officers give brief reports on operations anprospects for current year.


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pecia% Meetings* 6are, called when SH approval of corp action is necessary b/w annual meetings. "ay be called by

president, #)s, or the holders of /thor more of the shares entitled to vote at the meeting. )ther officeor persons 'chairman of the board( sometimes may call meeting.

Notice of Meetings* "#$% re&uires note of meetings to be given not less than "# or more than $# days before meetin

"ust give place, day, and hour. 3or special meetings, purpose must be given. 5f e+traordinary corp tr+n'merger(, notice of proposal must be given to %AA SHs, regardless of the SHs class of stock.I%f reuired notice isnt given, actions taken at meeting are of no effect. SHs who didnt give proper notic

may waive notice. %ttendance at meeting is automatic waiver. No waiver if SH attends only to ob@ect theholding of the meeting. Jaiver is effective only if all SHs who didnt get proper notice either attend orwaive in writing.

&emote Participation* 5f a SH meeting is to be conducted remotely* 'modern comm. Tech(

.( the corp must have implemented some reasonable means for ensuing that those participating are indeed SHs..( Those participating SHs and pro+y holders must be afforded a reasonable opportunity to both participate and

vote.1.( Some means must be provided so that participants have the opportunity to read/hear ongoing proceedings.2.( The corp must keep a record of any remote votes or other actions taken at meeting.

6ules governing remote participation by SHs dont Lhave to meet same retention, retrieval, review, and

reproduction re&uirements imposed on directors actions. % directors action by remote transmissionwouldnt be valid unless it could be reproduced in paper form, and a SH meeting may now be conductby conference call.

hareho%ders Entit%ed to .ote

o ources of the &ight to .ote* epends on incorp statute, articles and bylaws of corp. "ost common

stock listed in your name gives right to vote.

o !etermining Who Ma1 .ote* The person who has legal title to the stock. Those who are owners of

shares held in the name of another 'stock broker( may obtain a pro+y from record holder.

o Non+(oting toc>* Nonvoting class of stock holders have right to vote only under certain

circumstances, such as e+traordinary corp tr+ns. Neither a corp nor its subsidiary may vote treasury shares

Pro1 .oting* %s a SH, you may appoint another person 'pro+y( to vote for you."#$% re&uires written document, also called a pro+y. Some states permit oral pro+y. Denerally can berevoked at any time. %utomatically revoked if you later give another pro+y on the same shares of stock.! "odern statutes permit creation of irre(oca,%e proieswhich define when a pro+y may be irrevocable'"#$% allows for this if it so states and if it is coupled with an interest-! Coup%ed "6 an Interest* 8ro+y holder is a party to a SH voting agreement or has agreed to purchase thshares under a buy!and!sell agreement.

o o%icitation of Proies* 5n publicly held corps, only a small proportion of the shares are owned by persons who

attend the meetings. "gmt then solicits pro+ies, it asks the SHs who dont e+pect to attend to appoint, as theirpro+y, one or more of the directors or some other person friendly to mgmt.

o &egu%ation of Proies* S0$ has power under the =12 act to make rules about pro+ies. "ust give certaininfo, such as info about any employment contract and pension or stock option benefits and any materialtr+ns. %n annual statement must be mailed w/ or before the pro+y statement for an annual meeting.

The pro+y doc 'under S0$ rules( must permit SHs a choice of voting for or withholding their vote from a

of mgmts slate of directors. "ay also e+empt one or more directors from their favorable vote. "ust bepermitted to abstain or vote for or against any proposed resolutions.

S0$ rules re&uire corps sub@ect to them to furnish a SH list to any SH who wants to solicit pro+ies. $orp

may main the pro+y material for soliciting SH.

o Epenses* $orp pays for the prep and mailing of a pro+y on behalf of mgmt. 5f someone else wants to


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nominate directors, that group must bear the e+pense of soliciting pro+ies. 8ro+y battles are very e+pensive anfew challengers win. 5f they do, they are entitled to be reimbursed by the corp b/c its assumed from SH suppothe corp has benefited.

o Effect* SHs usually follow recommendation of mgmt in their voting or @ust sign the pro+y w/out voting. 8ro+y

usually gives mgmt authority to vote the shares on any matter. The effect is to determine the outcome of the meetinbefore its held. %rgument made for or against a resolution at the meeting can affect only the votes of those presen% resolution made from the floor has no chance of passing unless the mgmt votes its pro+ies in favor of it. Througpro+y system, mgmt is able to control the corp w/out owning many shares.

hareho%der Proposa%s and &ight to pea>

ources of = &ights*

.( 'n owner is to be informed about his investment, as> 'uestionsto discover economic conditions or corp sociapolicies.

.( 'n owner can participate in establishing the frameworkw/in which the directors e+ercise their powers of mgm'right to govern property interest( and propose reso%utionsto

%.( Protect in(estment* 8roposals to amend the corp articles to put ceilings on salaries of top e+eand limit corp gifts to charitable and educations orgs.

#.( Maintain socia% (a%ues* 8roposals with goals of social/political change that oppose certain coactivities. Shares may be purchased solely to permit making the proposal. E* %sking directoror corps to withdraw from S. %frica until apartheid ended, or publici:ing certain info withheldconfidential.

Cumu%ati(e .oting* To give minority SHs an opportunity to be represented on the board.

0ach share is entitled to one vote, but many corps permit SHs to cumulate their votes to support one direct)pponents say it is likely to be troublesome and cause friction among #) members. States that re&uirecorps to allow SHs to cumulate votes have few large publicly held corps.

K E 'S/>( > K E 9 of shares re&uired to elect one director under cumulate voting.S E 9 of shares voting E Total 9 of directors to be elected.

&ights of Inspection # Preempti(e &ight

MBCA re&uires a corp to send its latest financial statements to any SH on re&uest, and tpermit a SH 'on written re&uest( to e+amine in person, or thru an agent such as a lawyer, its relevant bookand records of account, minutes, and record of SHs. "ay make e+tracts from these records.

o Proper Purpose: SH must have proper purpose for e+amining records, such as to determine the value o

ones shares or identify fellow SHs to communicate w/ them concerning corp affairs, or to make a copy the SH list to wage a pro+y contest to unseat present mgmt. Not proper cause* To learn business secrets gain a competitive advantage.

o !enia%s:"#$% makes a corp official who denies a proper demand liable for penalty of M of

the value of the shares of the demanding SH. "any states dont have such penalties, so denialsare common.

Preempti(e &ights: "any states re&uire corps domiciled there to give their current SHs an opti

to purchase their proportionate share of any new issue of stock. 0nables SH to maintain the same relative interest ithe corp as before. $reates difficult problems in large corps that have several classes of stock. oesnt apply totreasury shares, shares issued in connection w/ a merger/consolidation, or shares issued in e+change for property/pservices. No preemptive right unless the articles create such a right.

!i(idends

!irectors/ !iscretion to Pa1 !i(idends: SH have a right to share in N0, but the declaration of

dividends is sub@ect to business @udgment of #). They cant pile up unneeded cash in the treasury or pay it out inunreasonable high salaries to mgmt. Burden of proof is on =to show that the directors have abused theirdiscretion.


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1pes of !i(idends

o Cash and Propert1 !i(idends: ;sually cash, may be property dividends in form of

shares of stock the corp owns in another corp or any other non!cash asset.o toc> !i(idends:istributions of share in the corp itself.;su paid when mgmt wants t

retain all or an unusually high proportion of earnings for reinvestment. "ain purpose may be a reductionin the mkt price per share to encourage greater investor interest. Stock dividends payable in the same claof shares do not change a SHs stake in the corp, the proportion of shares owned remains the same, @ust ahigh 9 or shares.

Lega% Limits on !i(idends: MBCApermits paying dividends only out of 60. 8rohibits pmt of

dividend that would make the corp insolvent 'cant pay its debts as they become due(.

toc> p%it:Not a dividend, it changes the par/stated value of the shares and increases the 9 of

shares outstanding, not the retained earnings account. 6everse stock split* reduces the 9 of shares outstanding.6eason* To ad@ust the price of the stock to one that mgmt believes is more appropriate. Stock prices too high mdiscourage investors from buying, prices too low appear less desirable.

+ 5f articles have not previously authori:ed a share split, it cant be made until a favorable vote of SH. )nlyvote of directors is necessary for a stock dividend unless addl shares must be authori:ed 'an amendment toincrease the 9 of authori:ed shares(.

!i(idends on Preferred toc>: 8reference in dividends over common Shs.o ividends on cumu%ati(e preferred stoc>, if not paid in any year, will be payable later

when funds are available.

o ividends on non+cumu%ati(e preferred stoc>need not be paid later if they are not

earned and paid in the year due.o Participating Preferred* Holders get their usual dividend, then, after the common SHs

receive a prescribed normal- dividend, the preferred SHs participate w/ the common SHs in incomeavailable for dividends.

o 5f the preference is cumu%ati(e to the etent earned, the preferred SH has a right, befo

common SHs receive any dividends, to be paid all dividends that were not declared when earned in prioyrs.

Effect of !i(idend !ec%aration: )nce directors have voted to pay a lawful dividend, it becomedebt of the corp. irectors usually set a record date. 5f a sale is made on a stock e+change, the purchaser is entitleto the dividend unless the sale occurs on or after the e di(idenddate, which is two business days before the recordate for the dividend.

hareho%der &ights in Etraordinar1 Corp ransactions

Amendment of Artic%es: "#$% re&uires approval by ma@ority of shares entitled to vote but

permits the articles of incorp to impose a higher re&uirement. 5f amendment would affect the rights of a clof shares, SHs of that class have a right to vote as a class even though those SHs normally have no vote 'eproposal to eliminate a provision for cumulative dividends on a class of preferred stock(.

)ther Etraordinar1 ransactions

oMergers6Conso%idation: %pproval of all classes of shares is re&uired.

o Sale of most of the corp assets or a voluntary dissolution also re&uires favorable vote4

Appraisa% &ights: Diven to SHs who vote against certain tr+ns 'such as a merger( when the ma@ority are in favor, you

may demand that the corp pay you the fair value of your shares.o Actions Co(ered: ;nder "#$%, the right of appraisal applies in cases of mergers or a

sale of most of the corp assets. %lso applies to amendments to the articles that would materiallyaffect li&uidation, dividend, redemption, preemptive, or voting right.

o Procedures: SHs can only e+ercise the right only if they did not vote in favor of the tr+

"ost statutes insist that the dissenting SHs notify the corp of their intent to e+ercise the right befothe actual vote has taken pace.


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"ust actually demand payment. 5f cant agree on amount, ask a court to appraise value.o Ec%usions* "ost states deny the right of appraisal to shares that are traded on a recogni:ed securities

e+change, b/c of the belief that the securities mkt is the best determinant of the value of shares.

La"suits ,1 hareho%ders

Indi(idua% Actions: SHs may sue the corp for a breach of their SH contract. $ontract is a produ

of the corp articles/bylaws and any #) resolution is applicable to the particular stock issue, as well as the costatute. 5ts not a doc signed by the SH and the corp.

C%ass Actions: Jhen a 9 of people have a right/claim against the same defendant growing out o

the same set of facts. 0+* 5f the corp didnt pay a preferred dividend that was due. 5f you win, you can collect tdividends and recover from the corp the e+penses in bringing suit.

!eri(ati(e Action: SHs not usu able to sue to enforce a right of the corp. 0+* Suppose an office

of the corp has breached his duty by setting up a business to compete w/ the corp and has made C mil ate+pense of the corp. % SH couldnt sue b/c a corp is a legal entity separate from SHs.o' S( is permitted to sue as a representative of the corp when these reuirements are met*

.( SH must have owned shares at the time of the wrong..( The SH must urge the directors and, if appropriate, the other SHs to direct that such a suit be brought

the corp.

I= on%1 permitted to ,ring suitif the directors refuse of have conflict of interest that is likely to keepthem from suing. 5f the SH wins, the damages go to the corp, but the SH will be reimbursed for her e+penin bringing the suit.

o pecia% Litigation Committees: Jhen SHs file a derivative lawsuit, corps may establi

a SA$ to determine if the claim should be pursued, settled, or otherwise terminated. 5f SA$ recommends ta derivative suit be terminated, the SA$ persuade it that*.( 5ts members were independent.( They acted in good faith.1.( They had a reasonable bases for their recommendations.I8ermit a corp to terminate a derivative suit if its board is comprised of directors who can impartiallyconsider a demand. 8rimary means which corp defendants may obtain a dismissal of a derivative suit if th

conclude that the plaintiffs have not met their pleading burden.

hareho%der Lia,i%it1

Lia,i%it1 on hares: 5f a person buys stock that was fully paid for when issued, or subse&uent

buyers of stock regardless of price paid, he normally has no further liability to the corp or its creditors.! % SH who didnt pay the full subscription price for newly issued shares is liable for the balance due.

'includes "atered stoc>- situations where property e+changed for shares is overvalued.! SH is also liable if the consideration given for the shares is not lawful payment under the incorp statute.

Lia,i%it1 for I%%ega% !i(idends: % dividend that was paid illegally may be recovered from a SH who received it

knowing it was illegal. 5f the corp was insolvent that the time, the SH is liable even if he wasunaware of the illegality.

ransfer # &edemption of hares

&estrictions: SH has right to sell/give away her shares unless there is a valid restriction. ;nder

S0$ rules, selling may be restricted b/c the shares were part of a private offering.! 5n close corps, the original SHs may not want to have to deal w/ strangers.+ %n agreement by all of them to re&uire any SH who desires to sell to give the corp or other SHs a fir

right to purchase the shares would be upheld by courts.+ Notice of a restriction on the right of sale must be conspicuously placed on the stock certificate to b

effective against a purchaser who is unaware of it.

ransfer Procedures: To transfer the stock, the owner endorses the assignment form usu printe

on the back of the stock cert. %n assignment may also be made by a separate doc called astock power. #anks us


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Eemptions from the &egistration &e'uirements* 0very tr+n in securities must be

registered w/ S0$ or be e+empt from registration 'which is very costly and time!consuming(..( Eemptecurities* Never need to be registered, regardless of who sells them, how they are sold, or to

whom.a. The character of the issuer makes registration unnecessary.b. The issuance of such securities is sub@ect to regulation under another statutory schemec. The purchasers of securities can ade&uately protect themselves.Most important securit1 eemptions*a. Dovt issued or guaranteed securities.b. Short!term notes F drafts.d. Securities of nonprofit issuers.e. 3inancial institution securities.f. 5$$!regulated issuers.g. 5nsurance policies and annuity contracts.INot e+empt from antifraud provisions of the act. %ny fraud committed in the course of selling thsecurities can be attacked by S0$ and by those involved.

.( ransaction Eemptions*'most important(Securities are e+empt from the registration re&uirements those particular tr+ns only. 0ach trn+ stands by itself, a security sale may be e+empt today b/c it is soldpursuant to a tr+n e+emption, yet tomorrow it may have to be registered when the security is offered osold again in a tr+n for which there isnt an e+emption.INot e+empt from antifraud provisions of the act.

a. Several e!emptions for non+issuers ,average investors(. )ne provision e+empts tr!ns by anyperson other than an issuer- underwriter- or dealer-, used my most investors when they sellsecurities 'e+* buy D"$ common shares on NPS0, you are not an issuer 'D" is(, you arent underwriter 'youre not helping D" distribute shares, and you arent a dealer 'youre not inbusiness of selling securities(.

b. Several e!emptions for issuers* 8rivate offering, the intrastate offering, and small offering.

Antifraud Pro(isions of the 3977 Act* 8reventing fraud and deceptive practices and providing remedies to victims.

Lia,i%it1 for Improper )ffers # a%es* Imposes %ia,i%it1 on any person who has

violated the timing, manner, and content restrictions on offers and sales of new issues.+ Purchaser/s remed1is rescission or damages. )ccur when a person offers or sells unregistered andnone+empt securities in violation of =11 %ct.

Lia,i%it1 for !efecti(e &egistration tatements* Section . 8rovides civil liabilit

for damages resulting to an investor who finds, after purchasing the security, that the registration stmt for tsecurity contained an untrue stmt or omitted a material fact.+ Potentia%%1 %ia,%eare all of it signers, all directors 'whether or not they signed(, all e+perts- who caveconsent to be named in the reg stmt as having prepared/certified part of it 'auditors, lawyers, geologists,engineers(, and the underwriters of the distribution of the security.+ Purchaser/s remed1is for damages caused by misstatement/omission.! ection 33 is radica% for 7 reasons*

. &e%ianceon misstatement or omission in reg stmt is not usua%%1 re'uired.. Pri(it1 is not re'uired, a purchaser doesnt need to prove she purchased the securitie

from the defendant.1. Purchaser need not pro(e that the defendant neg%igent%1 or intentiona%%1 misstat

or omitted a materia% fact. efendant has the burden of proving that he e+ercised dudiligence.

)ther Lia,i%it1 Pro(isions*

o ection 3225prohibits misstatements/omissions of material fact made in a

prospectus or in an oral comm. 6elated to the prospectus or an initial offering 'e+cept govt!issuor guaranteed securities(. "ere neg%igence, rather thanscienter'intent to deceive, manipulate(, enough to trigger %ia,i%it1.


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+ Has a pri(it1 re'uirement, the purchaser may only sue those person from who she purchasethe security, and must sho" she re%ied on the misstatement6omissionand didnt know of theuntruth.! !efendant ma1 escape %ia,i%it1by proving he didnt know and count have reasonable knowof the untruth/omission.! Purchaser/s remed1is rescission or damages? recoveries are available to purchasers of initiadistributions, not to those trading in secondary mkt.

o ection 3a5: #roadly prohibits use of any device/artifice to defraud and the

use of any untrue/misleading stmt in connection w/ the offer/sale of any security. subsectionsre&uire that the defendant merely act negligently, 1rdsubsection re&uires proof of scienter.

ecurities Echange Act of 397?: $oncerned w/ disclosing materi

info to investors, re&uires periodic disclosure by issuers w/ publicly held e&uity securities. 6egulates insiders trin securities, pro+y solicitations, tender offers, brokers and dealers, and securities e+changes. Several sectionsprohibiting fraud and manipulation.

&egistration of ecurities under 397? Act: types of securities must be registered*

.( 5ssuer must register a class of e&uity securities w/ at least 4 SHs if the issuers total assets e+ceed 1 mil.Securities must be traded in interstate commerce.

.( 5ssuer must register any security traded on a natl security e+change 'common shares on %S0(.

Periodic &eports* 5ssuers re&uired to register under =12 %ct and any issuer who has made a registered offering und

the =11 %ct must file periodic reports w/ S0$.o 3


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&egu%ation of Pro1 o%icitations* S0$ rules re&uire that any person soliciting pro+ies from

holders of securities registered under =12 %ct furnish each SH w/ a pro+y stmt w/ info to be able todetermine whether to give pro+y to another person and how to direct that person to vote. .sually the onlyparty soliciting pro!ies is the corps mgmtin order to reelect itself to #). 5f the mgmt of the corp doesntsolicit pro+ies, it must nevertheless inform the SHs of material info affecting matters to be put to a voite oSHs. This info stmt, which contains about the same info as pro+y stmt, must be sent to all SHs entitled tovote.

=s of pu,%ic corps rare%1 attend = meetings so the1 (ote through proies.

Lia,i%it1 Pro(isions of the 397? Act: 8rovide remedies to victims of fraudulent/deceptive practices.

Manipu%ation of a ecurities Price* Sec. = prohibits a 9 of deceptive practices that cause

security prices to rise or fall by fraudulently stimulating mkt activity 'when a person simultaneously buysand sells the same stock in order to stimulate substantial trading activity O "ash sa%e(.

Lia,i%it1 for 0a%se tatements in 0i%ed !ocuments* Sec. R imposes liability on any

person responsible for false/misleading stmts of material fact in any doc filed w/ S0$ '!B, !


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o Insider rading* % person w/ inside info must either disclose the info before trading or refrain from tradin

%pplies to almost anyone, not @ust those who are actually viewed as insiders, such as directors, officers, anowners of a ma@or interest in the company. 5ncludes secretaries, employees such as researchers or geologisand their supervisors, outside consultants, lawyers, engineers, financial and 86 advisors, news reporters, apersonnel of govt agencies.! ippies* Those who are given or ac&uired the info w/out the need to know, such as stockbrokers orfinancial analysts and even relatives or friends of those w/ access to inside info, are forbidden to trade on tinfo.! 0or (io%ation of insider trading ru%es, the S0$ may seek a civil penalty of 1+ the profit gained or lossavoided. re,%e pena%t15 %lso can be punished criminally 'e+* C mil fine, yrs prison(.!0K* "artha Stewarts arrest after receiving insider information regarding a pharmaceutical company notgetting a drug approved by the 3%. She could have @ust been fined but she lied to officials and ended upwith @ail time.! tatute of Limitations* 4 years after the violations occurred.

afe =ar,or Legis%ation* 0nd of ==4, $ongress passed new legislation to curb lawsuits

against companies whose stock performance fails to live up to e+pectations. The law discourages the filing oflawsuits by re&uiring that plaintiffs plead specific facts that corp insiders knew they were committing fraud whthey made stmts pro@ecting a companys future performance.o New law erects a safe har,orfor companies that make optimistic forecasts about future earnings or new

products. %s long as companies warn the public about factors that might undermine their corecasts, they wbe immune from liability if the predictions prove false. Aegislation is vague about how specific the warninmust be and fails to define e+actly what types of factors must be identified.

Internationa% Cooperation*S0$ pursued strategies to protect ;S investors throughout the world..( %sserted broad e+traterritorial @urisdiction over global tr+ns that affect ;S commerce.

.( 3ormation of mutual legal assistance treaties and memoranda of understanding b/w the ;S and its tradingpartners.

ISeeks cooperation b/w the S0$ and securities regulators from other countries.

ender )ffer &egu%ation

=istor1* ;ntil early =Qs, one corp ac&uired another through the merger, which re&uire

the cooperation of the ac&uired corps mgmt.ince the 39Fground of ,idder, and the purpose of the tender offer'including whether the bidder intends tcontrol the sub@ect company(.! S0$ rule re&uires bidder to >eep tender offer open for at %east 2< ,usiness da1sand prohibits any purchase oshares during that time. Dive SHs ade&uate time to make informed decisions to tender their shares.! 5f bidder increases the offering price during term of offer, all SHs must be paid the higher price even if theytendered their shares at a lower price.! 5f more shares are tendered than the bidder offered to buy, the bidder must prorate purchases among all sharestendered. esigned to foster careful SH decisions about whether to sell shares.

tate &egu%ation of ender )ffers: "ost states have statutes regulating tender offers to protect local corps from

hostile takeovers, re&uiring long periods of advance notice to the target co and long minimum offering periods.


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tate ecurities Legis%ation: aka blue!sky laws since the early statutes were designed to protect investors from promotersand security salespersons who offered stock in companies organi:ed to pursue visionary schemes. %ll states provide penaltfor fraudulent sales and permit the issuance of in@unctions to protect investors from addtl or anticipated fraudulent acts."ost states grant broad power to investigate fraud to some state official O usu %ttorney Deneral.

State security laws also called blue sky laws-

Bro>er+!ea%er &egistration* "ost state securities statutes regulate prof sellers of securit

'securities brokers and dealers(. "ust register securities brokers and re&uire proof of the financialresponsibility of dealers. ealers must disclose pertinent facts about the securities they are selling and avoidsales of fraudulent securities.

niform ecurities Act* 5n =R4, the Natl $onference of $ommissioners on ;niform St

Aaws adopted a new ;niform Securities %ct 'replaced =Q4 %ct(. $ontains antifraud provisions, re&uireregistration of securities, and demand broker!dealer registration.! 8ermit an issuer to register its securities by coordination. 5nstead of filing a registration stmt under the =%ct and a different one as re&uired by state law, registration by coordination allows issuer to file the =11 %registration stmt w/ the state securities admin. ecreases the issuers e+pense of complying w/ state law whemaking an interstate offering of securities.

Chapter 72: Lega% Lia,i%it1 of Accountants

Bases for Lia,i%it1* #asis of accountants liability is the duty to e+ercise ordinary skill and care. #reach of this dutycould lead to tort of negligence, or breach of contract b/w accountant and client. Sometimes violation isfraudulent or even criminal. 5f a partner in a public firm is responsible for wrongdoing, the law ofpartnership will be involved, prob resulting in liability for all partners in firm. 'if acct is an employee and partner, firm may still be held liable under respondeat superior(. $an be both ci(i%or crimina%.

Common La" Lia,i%it1 to C%ients

Contractua% Lia,i%it1* 5f an acctg firm agrees to complete an audit for a prospective lend

by /4 'an informed deadline( and doesnt finished until "arch and the lender runs out of funds, the acctwould be liable for the clients resulting loss. The acctg firms other deadlines arent a defense, but the firmwouldnt be liable if the client obstructed performance by refusing access to records.

oNo !e%egation &u%e: )rdinarily, an accountant cant delegate his duties w/out consent of client b/c the contract personal, based on the skill, training, and personality of the acct.

ort Lia,i%it1

oNeg%igence* %n accts failure to follow instructions of firm or duty of care for an acct may lead to

negligence if the client suffers damages.3ailure of an acct to discover fraud by client is not in itself proof of negligence by acct.

Notifying an appropriate person is necessary when fraud is suspected, but never to the person suspected

of fraud.Contri,utor1 Neg%igenceand Comparati(e Neg%igenceare traditional defenses that may apply to a

negligence action. "ore likely to succeed when the client failed to follow accts advice.$lient is limited to recovering compensatory damages.

o 0raud* 5ntentional misrep of material facts or intentional failure to disclose such info. %cting w/scienter

'knowledge of an untruth or reckless disregard for truth(.$lient may recover compensatory damages 'amount that will repleace the actuall loss caused by

accts wrong. "ay be able to recover punitive damages as well 'amt in e+cess of actual loss to punishacct(

Common La" Lia,i%it1 to 7rd Persons* such as creditors, SHs, or other investors who rely on audited 3/Ss.

Pri(it1 !octrine* Aimits recovery to those w/ a direct contractual relationship to acct.

historically, 1rdparty suits against accts were generally barred by this.


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Contract past approach5* %t common law, recovery by a creditor was possible b/c the

creditor was considered a 1rdparty beneficiary of the contract employing the acct. 6e&uired showingthat the acct was aware that the audit was ordered to satisfy creditor. $ontract law has not been wideused by 1rdpersons suffering damages b/c of accts.

Neg%igence past approach5* "any courts carried privity doctrine to negligence suits by

persons. These non!clients 'creditors, SHs, etc( were prevented from recovering damages caused byaccts negligence. %ccts did not owe a duty of care and skill to non!clients.

Current Approaches to 7

rd

Part1 Neg%igence Actions* "any courts today refuse to applprivity doctrine to 1rdparty negligence suits against accountants. They use*

345 he UltramaresApproach: 7rdPart1 can/t reco(er un%ess in pri(it1. ;ltramares vs. Touche? auditor not tthat ;ltramares $orp was to receive of 1 signed certified #/S, yet auditors were clearly negligent in makitheir audit. They accepted w/out &uestion as C, in fake sales, although these and other entries shouldhave aroused their suspicions. Gdg $ardo:o refused to hold acctg firm liable 5f liability for negligencee+ists, a thoughtless slip or blunder, the failure to detect a theft/forgery beneath the cover of deceptive entriemay e+pose accts to a liability in an indeterminate amt for an indeterminate time to an indeterminate class.-

245 he Near Pri(it1 Approach: 3rom case where a seller employed a weightier to certify weight of beans andprovide a copy of certification to buyers. Gdg $ardo:o held for the buyer in a suit against the weightier for

inaccurately certifying the weight of beans. %ccts may be liable in negligence to 1

rd

parties when*a4 The accts must have been a"are that the 06s "ere to ,e used for a particu%ar purpose.,4 The acct must have known the identit1 of the 7rdparties that they would rely on reports.c4 0vidence that acct >ne" re%iance "ou%d occur.

745 he &estatement 2nd5 Approach: %cct is liable only to those 1rdparties who are specifically foreseeable-greater liability on accts than .ltramares. &e'uires the acct ,e a"are that audited materia% "ou%d ,e use,1 7rdparties4oes not protect the typical investor who was unknown to acct and her client when 3/S wereprepared. States who abandon ;ltramares use this approach.

?45 he &easona,%1 0oreseea,%e sers Approach: 0+poses a negligent acct to greater liability than ;ltramareand 6estatement. %cct could be held liable to unknown but reasonably foreseeable users if*

a4 ;ser must have received the 3/S from the accts client for a proper business purpose.,4 The 1rdperson must have reasonably relied on accuracy of 3/S.c4 The damages suffered by 1rdparty must be a foreseeable result of accts negligence.

G45 he Ba%ancing Approach: "ore fle+ible/e&uitable standard for resolving 1rdparty negligence suits againstaccts. 1rdparty may recover if they meet the si+factor ,a%ancing test that eamines*

a4 The e+tent to which the tr+n was intended to affect the plaintiff.,4 The foresee!ability of harm to plaintiff.c4 The degree of certainty that the plaintiff suffered [email protected] The closeness of the connection b/w the defendants conduct and the in@ury suffered.e4 The moral blame attached to the defendants conduct.f4 The policy of preventing future harm.

0raud: $ourts have e+tended an accts liability for fraudulent conduct to all foreseeable

users of her work product who suffered damages that were pro+imately cause by accts fraud. To provefraud, must be shown acct acted w/ scienter 'intent(. 0+* rather than e+amining current figures in a clienbooks, an acct relies on last years figures, or recogni:ing obvious evidence of embe::lement yet failingnotify client of it.

!ut1 to !isc%ose Ne" Info:uty of care of accts e+tends beyond their actions durin

the audit itself, they have a duty to disclose the unreliability of the earlier report to anyone whothey knew was relying on it. $ould be negligence or fraud.

tatutor1 Lia,i%it1 of Accountants


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0edera% ecurities Act

oCi(i% Actions under the 3977 Act: Section 'a( e+plicitly imposes liability on accts for misstatements/omissio

of material facts in info they furnish for registration stmts re&uired by =11 %ct. %lso applies tolawyers/other e+perts. Aiable to any purchaser of securities issued pursuant to a defected registration stm

8urchaser need not prove reliance

Burden is on accountant'must prove he e+ercised due diligence, D%%S, D%%8(

%cct not liable if he can prove the purchaser was aware of the misstatement.

%ccts duty is to have a reasonable belief in accuracy of figures at time the registration stmt

becomes effective 'usu several months after audit was completed(, so the acct has continuing dto review the audited stmts until effective date and correct any material changes.

tatute of Limitations* 8urchaser must sue acct w/in one year after time the

misstatement/omission was or should have been discovered. However, a suit may not be broughmore than 1 years after the securities were offered to the public.

o Ci(i% Actions under the 397? Act: Section 'b( prohibits any person from making a

misstatement or omission of a material fact in connection w/ the purchase or sale of any security.8urchaser or seller must rely on the misstatement/omission, but sometimes courts allowed plaintiffs torecover even though they hadnt read the report containing omissions.

8opularity of this rule among plaintiffs is somewhat diminished by the re&uirement thatsometh

more than negligencemust be shown to make defendant liable 'scienter, intentional or knowing

misrep, reckless disregard of facts(.

ection 3a5imposes liability on accts who furnish false or misleading info in any report/doc

filed w/ SEC. Jhile privity is not a defense in Sec R, it is still not widely used b/c it contains astringent reliance re&uirement 'purchaser/seller must have actually read the false info O investorseldom read many docs filed w/ S0$(.

%ccts may be liable for assisting aiding and a,etting5 others in violating S0$ laws, even if in

was prepared by others. %ccts must report any illegal activities uncovered in audit.

New legislation shields accts from theHoint+and+se(era% %ia,i%it1 s1stem 'an acctg firm could b

held liable for the full amt of a @udgment if the defendant corp became insolvent(. New regulatiolimits the acctg firms liability to the proportion of the fraud for which the accts were responsiblplus a 4M premium when main defendant is insolvent.

o Crimina% Lia,i%it1: =11* % willful 'intentional( misrep/omission in a registration stmt is criminal.=12* To willfully make a fast or misleading stmt in reports that are re&uired to be filed witS0$. Jillful violation of 6ule b!4 is also a crime.

o tate ecurities Acts* %ll states have statutes that contain liability provisions, some that specifically

impose criminal penalties on accts for willful falsification of 3/S, but few actions have been brought againaccts under these statutes, but this might change as plaintiffs recogni:e difficulty of proving scienter under6ule !b.

o Lia,i%it1 for a Wor>* %ccts may be held liable for negligence in preparing ta+ returns and giving ta+

advice. 0+ample* %n acct may be re&uired to reimburse a client for a penalty imposed for the late filing if delay is caused by acct. )r an acct who erroneously tells a client a tr+n is nonta+able when it actually is.

o Administrati(e Proceedings* %n acct who violates the fed securities acts may be sub@ected to an admin

hearing conducted by S0$, where an admin law @udge will first hear the case and make a determination. TS0$ commissioners will then issue a final order. S0$ possesses the authority to temporarily or permanentbar an acct from practicing before it. 3inal order of S0$ may be appealed to a fed court of appeals.

o Professiona% Conduct* "ost states have licensing boards that regulate the ethical conduct of acct prof.

State agencies may suspend or revoke accts license to practice in that state if she commits illegal/unethicaacts. Strict regulation of advertising in acctg prof is now a thing of the past.


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-ua%ified )pinions and !isc%aimers: %fter audit completed, acct must issue an opinion letter.! n'ua%ified )pinion* 5n accts opinion, there has been compliance w/ D%%8 and D%%S.

-ua%ified )pinion* Jhen there is some kind of issue, for e+ample, a pending litigation against the client.;ncertainty over how the litigation will be decided may cast a cloud of doubt over financial condition of company6elieves acct of any responsibility for ma@or changes in the clients financial position due to an unfavorable verdic

!isc%aimer* Jhen an acct may have conducted such a limited audit that she doesnt feel able to offer an opinion asto the accuracy of the clients 3/S. She would still be liable for any irregulatirites that her limited audit should have

revealed.

Ad(erse )pinion* To avoid liabilities for any irregularities discovered, accts issue an adverse opinion.! "erely issuing an unaudited stmt does not create a disclaimer as to the 3/S accuracy. 5t @ust lowers the levelof in&uiry for which the acct will be responsible.

Protection of Accountants/ Papers

Wor>ing Papers* Jorking papers from audit belong to acct, not client, b/c the acct may

need to @ustify his work before the 56S or a court. "ay include notes, plans for audit, results of testing todetermine reliability or accounts, comments about clients 5$. %cct must get clients permission before theycan be transferred to another acct. $lient has a right of access to working papers for any reasonable purpos'use of papers by an attorney defending client in a ta+ case(.

Accountant+C%ient Pri(i%ege: "any states have statutes that grand protection to accts

working papers and also to conversations, letters, and memos b/w accts and their clients. However, federacourts dont always recogni:e such state statutes.

o Eamp%e* % privilege of confidentiality has not, in the past, been recogni:ed in fed ta+ cases. %n acct m

be forced by a subpoena to make available to the 56S working papers involving a client who is beinginvestigated. %cct may also be forced to testify about the clients records and about convos that the accthad w/ client 'same w/ S0$ investigations(.

! iffers from lawyers and clients, their communication is treated as privileged.! 5n ==R, fed statute e+tended attorney!client privilege to a federally authori:ed ta+ practitioner-. oesnot protect work product.+Wor> Product Pri(i%ege:broad privilege against compelled disclosure of an attorneys work product.Today protection is e+tended to braider class of professionals. 5t now protects from discovery any documeand tangible things prepared in anticipation of litigation by or a party. 8arty asserting J88 bears burden oestablishing that docs he seeks to protect were prepared in anticipation of litigation-.

Chapter ??+ Ban>ruptc1

he 0edera% Ban>ruptc1 Act! The #ankruptcy %ct is a 3ederal Aaw that provides an organi:ed procedure under the supervision of afederal court for dealing with insolvent debtors. ebtors are considered insolvent if they are unable or failto pay theirs debts as they become due.!"ost recent revision to the bankruptcy law was passed on 2//4 by 8res. #ush called the#ankruptcy %buse, 8revention and $onsumer 8rotection %ct of 4. 'valid for cased filed after

//4(+e(era% MaHor purposes:

( to ensure that the debtors property is fairly distributed to the creditors and thatsome of the creditors do not obtain unfair advantage over the others

( The act is designed to protect all of the creditors against actions by the debtor thatwould unreasonably diminish the debtors assets to which they are entitled

1( 8rovides the honest debtor with a measure of protection against the demands forpayment by creditors 'in some cases, the debtor is given additional time to pay thecreditors free of pressures the creditors might otherwise e+ert.(

Ban>ruptc1 Proceedings

Ban>ruptc1 Actcovers several types of bankruptcy proceedings*( Straight #ankruptcy 'li&uidation(


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( 6eorgani:ations1( $onsumer debt ad@ustments

Li'uidations Chapter 5

! % li&uidation proceeding, traditionally called strait ,an>ruptc1, is brought under $hapter of the#ankruptcy %ct. The debtor must disclose all property show owns 'the bankruptcy estate( and surrender itto the ,an>ruptc1 trustee. The trustee separates out certain property that the debtor is permitted to keepand then administers, li&uidates, and distributes the remainder of the bankrupt debtors estate. 5f thebankrupt person has been honest in her business transactions and in the bankruptcy proceeding, she isusually given a discharge 'relieved( of her debts.

&eorgani;ations Chapter 335! $hapter of the #ankruptcy %ct provides a proceeding whereby a debtor who is engaged in businesscan work out a plan to try to solve financial problems under the supervision of a federal court 'contractbetween debtor and creditor(. The proceeding is intended for debtors, particularly businesses, whosefinancial problems may be solvable if they are given some time and guidance and if they are relieved ofsome pressure from creditors.

o 0ami%1 0arms and 0ishing )perations Chapter 325

! $hapter of the #ankruptcy %ct provides a special proceeding whereby a debtor involved in a familyfarming operation or a family owned commercial fishing operation can develop a plan to work outfinancial difficulties. %llowed to own and continue to operate farm until plan is implemented(

Consumer !e,t AdHustments Chapter 375! $hapter 1 of the #ankruptcy %ct sets out a special procedure that enables individuals with regular

income who are in financial difficulty to develop a plan under court supervision to satisfy their creditors.%llows compositions 'reductions( of debtors and/or time e+tensions to pay out of debtors future earnings.

Ban>ruptc1 Courts! #ankruptcy cases and proceedings are filed in federal district courts. 5f a dispute falls within what isknown as a core proceeding, the bankruptcy @udge 'appointed by pres for 2 yr term( can hear anddetermines the controversy. 5f dispute is a state claim, bankruptcy @udge drafts findings and conclusionsfor review by district @udge. $ertain kinds of proceeding what will have an effect on interstate commercehave to be heard by the district court @udge if any party re&uests that this be done.

Chapter : Li'uidation Proceedings

Petitions

.o%untar1 Petition filed by debtor5in bankruptcy me be filed by an individual, a partnership, or acorporation. However, municipal, railroad, insurance, and banking corporations and savings andloan associations are not permitted to file for li&uidation proceedings. 5t is not necessary for aperson who files a (o%untar1 petitionbe inso%(ent, that, be able to pay his debts as they becomedue. "ust be able to allege that he has debts. The primary purpose for filing a voluntary petitionto obtain a discharge e from some or all of the debts.-2005 Revision* established a new means testfor consumer debtors to be eligible for relief under

chapter . 5t ensures that individual who will have income in the future might be used topay off at least a portion of their debts must pursue chapter 1 as opposed to pursuingrelief and discharge of liabilities through li&uidation provisions under chap .

In(o%untar1 Petitions

+% petition filed by creditors of a debtor. The creditors seek to have the debtor declared bankrupt and his

assets distributed to the them.! Cannot ,e fie%d against :

( 3armers( 6anchers1( Nonprofit )rgani:ations2( "unicipal, railroad, and banking corporations4( $redit ;nionsQ( Savings and loan associations

! 5f a debtor has or more creditors, an involuntary petition to declare him bankrupt must be signed byat least 1 creditors. 5f there are fewer than creditors, an involuntary petition can be filed by a singlecreditor. The creditor or creditors must have valid aggregate claims against the debtor that e+ceed by


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C,1 or more the value of any security they hold. To be forced into involuntary bankruptcy the debtormust be unable to pay his debts as they become due or have had a custodian for his property appointedwithin the previous 2 months.! 5f an involuntary petition is filed against a debtor who is engaged in business, the debtor may bepermitted to continue to operate the business. However, an interim trusteemay be appointed by the courtif this is necessary to preserve the bankruptcy estate or to prevent loss of the estate.

-2005 Revisions:

&e'uirement for Credit Counse%ing and !e,tor Education

!5ndividuals are ineligible for relief under any chapter of the bankruptcy code unless within Rdays preceding their bankruptcy filing they received individual or group credit counseling froman approved nonprofit budget and credit counseling agency or receive an e+ception from the re&.The re&. briefing, can be done by telephone or internet, must outline- the opportun. forcounseling/ budget analysis. ebtor must file a certificate from agency that describes services andalso file any debt repayment plan developed by agency.Attorne1 Certification

+5ncreased liability for attorney who signs a bankruptcy petition. Signature constitutes acertification that they, after in&uiry, has no knowledge that the info contained in schedules filedby debtor are incorrect. Signature acts on a petition, motion or other written pleading constitutes acert. that they, after in&uiry, determined that the pleading is well grounded in fact and is eitherwarranted by e+isting law or is based on a good faith argument for e+tending e+isting law. 5f

motion signed by trustee to dismiss case for substantial abuse court may order debtors attorney toreimburse costs.

Automatic ta1 Pro(isions! The filing of a bankruptcy petition operates as an automatic sta1 'holds in abeyance( of various formsof creditor action against a debtor or his property. These actions include

( actions to begin or continue @udicial proceedings against the debtor( actions to obtain the possession of the debtors property1( actions to create, perfect, or enforce a lien against the debtors property2( actions to set off indebtedness owed to the debtor that arose before commencement of thebankruptcy proceeding

! % court may give a creditor relief from the stay if the creditor can show that the stay does not give him

ade&uate protection- and @eopardi:es his interest in certain property.!'==2( ebtors must either file a plan of reorgani:ation that has a reasonable chance of being confirmedwithin a reasonable time or must be making monthly payments to each such secured creditor that are in anamount e&ual to interest at a current fair market rate on the value of the creditors interest in the realestate.! '==2( %mendments also specifically provide that the automatic stay provisions are not applicable toactions to establish paternity? to establish or modify orders for alimony, support, or maintenance, or forthe collection of alimony, maintenance, or support from property that is not the property of thebankruptcy estate! 2005 Revisions:!%dditional 0+ceptions from the %utomatic Stay provisions for the benefit of landlords seeking to evicttenants. '( any eviction proceeding where landlord obtained @udgment of possession prior to filing of

bankruptcy petition can be continued '( if landlords claim for eviction based on use of illegal substanceson prop. or endangerment of the property, eviction proceedings are e+empt from the stay even ifintimidated after bankruptcy proceeding filed so long as endangerment occurred within 1 days beforefiling.!6evisions also include provisions dealing with serial filings for bankruptcy designed to keep debtorsfrom abusing auto. Stay provisions to the detriment of creditors.

)rder of &e%ief! 5f a voluntary petition was filed by the debtor or if the debtor does not contest an involuntary petition,this step is automatic. 5f the debtor contests an involuntary petition, then a trial is held on the &uestion ofwhether the court should order relief. The court orders relief only if


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( the debtor is generally not paying his debts as they become due( within four months of the filing of the petition, a custodian was appointed or took possessionof the debtors property

Meeting of Creditors and E%ection of rustee! The bankrupt person is re&uired to file a list of his assets, liabilities, and creditors, and a statement of hisfinancial affairs.-2005 Revisions:

New production re&.s on debtors. 5ndividuals must file along with their schedules of assets and liabilities

% certificate that they have received and/or read notice from $lerk of the #ankruptcy $ourt

that they must receive credit counseling to be eligible for relief under #ankrupt. $ode. $opies of all payment advices and other evidence or payment theyve received from

employer within Q days before filing of petition Statement of amt of monthly net income, itemi:ed to show how calculated.

Statement showing any anticipated increase in income or e+penses over month period after

date of filing petition.!Should an indiv. debtor in a voluntary chap. case or chap 1 case fail to file re&. info within 24 days offiling, case is auto. dismissed. 5f e+tension is @ustified court can e+tend time to submit paperwork to ma+of an additional 24 days.!5ndiv, debtors must also provide copies of recent ta+ returns to trustee and creditors making timely

re&uest! failure to do so can result in dismissal of case.

)nce court receives petition/cert/schedules! the meeting of creditors is called. %t the meeting, the ;nitedStates Trustee is re&uired to e+amine the debtor to make sure he is aware of*

( the potential conse&uences of seeking a discharge in bankruptcy, including the effects on credithistory( the debtors ability to file a petition under other chapters of the #ankruptcy %ct1( the effect of receiving a discharge of debts2( the effect of reaffirming a debt

! The creditors may elect a creditors committee. They also elect a trustee, who, if approved by the @udge,takes over administration of the bankrupts estate.!$reditors have chance to ask debtor


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!3inally, re&. for disposal of patient records where there are insufficient funds to continue to store them asre&. by law. 'proper notification to affected patients is also assumed(

o Li'uidation of 0inancia% 0irms

+#ankruptcy code contain special provisions for li&uidation of stockbrokers, commodity brokers andclearing banks that are designed to protect interests of customers of entities who have assets on depositwith the bankrupt debtor. 'overseen by trustee(

o he Ban>ruptc1 Estate

+$ommencement of chap bankrupt case by filing of involuntary or voluntary petition creates abankruptcy estate.+The estate is composed of all debtors legal and e&uitable interests in prop. 5ncluding certain communityproperty.+The estate also includes the following*

. 8rofits, royalties, rents and revenues along with proceeds from debtors estate received duringchap proceeding. 8roperty received by debtor in any of following ways within R days of chap petition filing'a( by be&uest or inheritance 'b( as a settlement with a divorces spouse or result of divorce decreeor 'c( as proceeds of a life insurance policy.1. 8roperty received by bankruptcy trustee because 'a( a creditor of debtor received a voidablepreferential transfer or 'b( the debtor made a fraudulent transfer of her assets to another person.

Eemptions! 0ven in li&uidation proceeding, the bankrupt is generally not re&uired to give up all of his property butrather is permitted to eempt certain items of property. ebtor can choose between state and federale+emptions.! ebtor may choose to keep either certain items of property that are e+empted by state law or certainitems that are e+empt under federal 'unless state forbids use of federal e+emption(.

-2005 Revision: The state or local law governing the debtors e+emptions is the law of the place where thedebtor was domiciled for 1 days before filing. 5f debtor didnt maintain domicile in a single stte for thatperiod, then the law governing the e+emptions is the law of the place of the debtors domicile for thema@ority of R day period that is between and U yrs before filing of petition.

!ebtor must elect to use either set of e+emptions provided by the state or federal bankruptcy law! shecannot pick and choose between them.!The eemptionspermit the bankrupt person to retain a minimum amount of assets considered necessaryto life and to his ability to continue to earn a living. 'fresh start philosophy( The general effect of thefederal e+emptions is to make a minimum e+emption to all debtors in every state.!States that wish, can provide liberal e+emptions called de,tors ha(ensJ* for e+ample! family #ible,tools or books of the debtors trade, life insurance policies, health aids, personal and household goods/@ewelry, furniture and cars worth up to a certain amount.! 32 Categoriesof property are e+empt under the federal e+emption which the debtor may elect in lieu ofthe state e+emptions.

The debtors interest not to e+ceed

"0 12"-32$ in value- in real property or personal property that the debtor or dependent of the

debtor uses as a residence20 14-5$# in one motor vehicle

40 up to a total of 1""-$2$ in household furnishings- household goods- wearing apparel-appliances- books- animals- crops- or musical instruments that are held primarily for the

personal- family- or household use of the debtor or a dependent of the debtor50 total interest of 1"-5## in )ewelry held primarily for the personal- family- or household use of

the debtor or a dependent of the debtor$0 1"-"$# in value of any other property of the debtors choosing- plus up to ('6F of unusedhomestead e!emption30 total interest of 12-"7$ in any implements- professional books- or tools of the trade

70 life insurance contracts


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80 %nterest up to 1""-$2$ in certain dividends or interest in certain life insurance policies90 Professionally prescribed health aids"#0 Social security- disability- alimony- and other benefits reasonably necessary for the support ofthe debtor or his dependents

""0 The debtors right to receive certain insurance and liability payments"20 *etirement funds that are in a fund or account that is e!empt from ta!ation under the %nternal*evenue Code: For certain retirement funds- the aggregate amount e!empted is limited to "million:

! The term value means fair market value as of the date of the filing of the petition.- 5n determining the

debtors interest in property, the amount of any liens against the property must be deducted

-2005 Revision:

o Limits on tate =omestead Eemptions

!Aimits on state homestead e+emptions include the following*. The value of the debtors homestead for purposed of a state homestead e+emption is reduced toe+tent it reflect an increase in value on acct of disposition of none+empt prop. #y debtor during yrs. 8rior to the filing with the intent to hinder, delay or defraud creditors.. %ny value in e+cess of C4,! irrespective of the debtors intent! that is added to the valueof a homestead during the 4 days '1yr, 2 mos.( preceding bankrupt. 3iling may not beincluded in state homestead e+emption unless it was transferred from another homestead in samestate or if is a principal residence of a family farmer.

1. %n absolute C4, homestead cap applies of 'a( bankruptcy court determines debtor beenconvicted of felony or 'b( debtor owes a debt arising from a violation of fed or state securitieslaws, fiduciary fraud, racketeering or crimes or intentional torts that caused serious in@ury ordeath in the preceding 4 yrs.

A(oidance of Liens

! The debtor is also permitted to (oid certain liens against e+empt properties that impair his e+emptions.The liens that can be avoided on this basis are @udicial liens or non possessory, non! purchase moneysecurities in

( household furnishings, household goods, wearing apparel, appliances, books, animals, crops,musical instruments, and @ewelry that are held primarily for the personal, family, or household useof the debtor or a dependent of the debtor

( implements, professional books, and tools of trade of the debtor or of a dependent of the debtor1( professionally prescribed health aids for the debtor or a dependent of the debtor.

-2005 revision:

!The household- goods as to which non!possessory purchase money security interest can be avoided hasbeen limited. The new definition limits electronics to one radio, one T7, one 7$6 and one computer.0+cluded are works of art other than those created by debtors and close family, @ewelry worth more thanC4 'e+cept wedding rings( and motor vehicles 'includes tractors, )67s, boats, planes(.

o &edemptions

! ebtors are also permitted to redeem e+empt property from secured creditors by paying them the (a%ueof the collateral. Then the creditor is an unsecured creditor to any remaining debt owed by the debtor.

!2005 revision:value of personal prop. Securing a claim of an indiv. debtor in a chap proceeding basedon cost to debtor of replacing prop! w/o deduct for costs of sale or mkting! and if prop was ac&uired forpersonal, family or household purposes, the replacement cost will be the retail price for prop of similarage and condition. ebtor is not permitted to retain collateral w/o redemption or reaffirmation of debt by@ust continuing to mk. payments on secured debt.

Preferentia% Pa1ments

! The trustee has the right to recover for the benefit of the bankruptcy estate preferential payments above acertain threshold that are make by the bankrupt debtor. 5f an indiv. debtor whose debts are primarilyconsumer debts, trustee isnt entitled to avoid preferences unless total value is VCQ . 5f a corporatedebtor, transfer by debtor of WC4 in aggregate isnt sub@ect to avoidance.


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!% preferentia% pa1ment is a payments made by an insolvent debtor within = days of the filing of thebankruptcy petition that enables the creditor receiving the payment to obtain a greater percentage of apree+isting debt than other similar creditors of the debtor receive.+E43red has C, in cash and no other assets. He owes CQ4 to his friend #ob, C,4 to the credit;nion, and C, to the finance company. 5f 3red pays CQ4 to #ob and then files for bankruptcy, he hasmade a preferential payment to #ob. #ob has obtained his debt paid in full whereas only C14 is left tosatisfy the C1,4 owed to the credit union and the finance company. They stand to recover only centson each dollar that 3red owes to them. The trustee has the right to get the CQ4 back from #ob.+The ==2 amendments provided that the trustee may not recover as preferential payments any bona fide

payments of debts to a spouse, fromer spouse, or child of the debtor for alimony, maintenance, or supportpursuant to a separation agreement, divorce decree, or other court order.

Preferentia% Liens! % creditor might try to obtain an advantage over other creditors by obtaining a lien on the debtorsproperty to secure an e+isting debt. Such liens are consideredpreferential and are invalid if they areobtained on property of an insolvent debtor within = days of the filing of a bankruptcy petition and thelien is to secure a pree+isting debt. % pref. lien obtained by insider within yr of bankruptcy can beavoided.E4 Deorge, a grocer, is insolvent. Deorges purchase of new inventory such as produce and meat for cashwould not be considered a preferential payment. Deroges assets have not been reduced? he simply hastraded money for goods to be sold in his business. Similarly, Deorge could buy a new display counter and

give the seller a security interest in the counter until he has paid for it. This is not a preferential lien Theseller of the counter has not gained an unfair advantage over other creditors, and Deorges assets have notbeen reduced by the transaction. The unfair advantage comes where an e+isting creditor tries to take a lienor obtain a payment of more than his share. The creditor has obtained a preference and it will bedisallowed.!The act also permits payments of accounts in the ordinary course of business.

o ransactions in the ordinar1 course of ,usiness

!The #ankruptcy %ct provides e+ceptions to the trustees avoiding power thatre designed to allow a debtorand his creditors to engage in ordinary business trans. They include*

'( Transfers that are intended by the debtor and creditor to be contemporaneous e+changes for newvalues'( $reation of a security interest in new prop where new value was given by the secured party to enable

the debtor to obtain the property and where the new value was in fact used by the debtor to obtain theprop. %nd the security interest was perfected w/i days after debtor took possession of collateral.!The #. %ct also provides an e+emption for transfers made in payment incurred in the ordinary course ofbusiness, like paying your utilities bill in a timely fashion without the creditor being vulnerable to havingthe transfer of funds avoided by the trustee.

0raudu%ent ransfers! 5f a debtor transfers property or incurs an obligation with intent to hinder- delay- or defraud creditors-the transfer is (oida,%eby the trustee. Similarly, transfers of property for less than reasonable value arevoidable by the trustee.E4Bathys in financial trouble so she sells her C4 car to her mom for C4.! This could be declared void by a trustee if it was made within a year before the filing of a bankruptcy

petition.! The provisions of law concerning fraudulent transfers are designed to prevent a debtor from concealingor disposing of his or her personal property in fraud of creditors.

C%aims! 5f creditors wish to participate in the estate of a bankrupt debtor, they must file a proof of c%aimin theestate within a certain time 'usually si+ months( after the first meeting of creditors. )nly unsecuredcreditors are re&uired to file proofs of claims? secured creditors do not have to do so. However, a securedcreditor whose secured claim e+ceeds t

cpa notes chapter 29-32,34,44

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