978-0134004006 Chapter 37 Lecture Note Part 2

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Corporate Governance and Sarbanes-Oxley Act

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Fiduciary Duty: Duty of Loyalty

The directors and officers must subordinate their personal interests to those of the corporation and

its shareholders. The most common breaches of the duty to loyalty include usurping a corporate

opportunity, self-dealing, competing with the corporation, and making a secret profit.

Self-dealing – Under the RMBCA, a contract or transaction with a corporate director or officer is

Competing with the Corporation – Directors and officers may not compete with the corporation

Making a Secret Profit – If a director or an officer breaches his or her duty of loyalty and makes

Case 37.2 Fiduciary Duties of Corporate Directors and Officers: McPadden v. Sidhu

president. VisionInfoSoft and its sister company, Material Express.com (together VIS/ME), a

competitor of TSC, made an offer to the i2 board of directors to purchase TSC for $25 million.

The i2 board of directors did not accept the offer. Over the next year, Dubreville engaged in

conduct whereby he artificially depressed the value of TSC by overstating costs, inaccurately

reporting TSC’s performance. Subsequently, the i2 board of directors decided to sell TSC. With

VIS/ME, who had previously made a $25 million bid to them to purchase TSC. The directors did

not contact any competitor of TSC to see if they would be interested in buying TSC. After a few

months, Holdings sold TSC for $25 million. John P. McDadden, a shareholder of i2, brought suit

in Delaware court. The suit alleged that the board of directors of i2 acted in bad faith when they

sold TSC to the Dubreville-led group for $3 million. The suit also named Dubreville as a

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Issue: Did the plaintiff plead sufficient facts of i2’s board of directors’ bad faith and Dubreville’s

Director Defendants’ duty of care, this violation is exculpated by the Section 102(b)(7) provision

in the company’s charter. Therefore the plaintiff’s case against i2’s directors was dismissed but

Ethics Questions: The fiduciary duty of care is a duty of corporate directors and officers to use

care and diligence when acting on behalf of the corporation. Whereas, the fiduciary duty of

they behaved negligently.

Sarbanes-Oxley Act

During the late 1990s and early 2000s, the U.S. economy was wracked by a number of business

and accounting scandals. In response, Congress enacted the federal Sarbanes-Oxley Act of 2002.

interests of all constituents.

Ethics: Sarbanes-Oxley Act Regulates Corporate Governance

The Sarbanes-Oxley Act is a federal statute that has changed the rules of corporate governance in

important respects. For example, the CEO and chief financial officer (CFO) of a public company

must file a statement accompanying each annual and quarterly report, certifying that the signing

accounting and corporate governance rules.

Ethics Questions: Students’ answers may vary. The CEO and CFO certification requirement

International Law: Foreign Corrupt Practices Act

V. Key Terms and Concepts

 Annual financial statement—A statement provided to the shareholders that contains a

balance sheet, an income statement, and a statement of changes in shareholder equity.

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shareholders.

 Business judgment rule—A rule that says directors and officers are not liable to the

corporation or its shareholders for honest mistakes of judgment.

 Buy-and-sell agreement—An agreement that requires selling shareholders to sell their

shares to the other shareholders or to the corporation at the price specified in the

agreement.

disinterested directors or shareholders approve the activity.

 Corporate electronic communications—Use of electronic transfers and electronic

networks by corporations to communicate to shareholders and among directors.

 Corporate officer—Employees of a corporation who are appointed by the board of

directors to manage the day-to-day operations of the corporation.

 Cumulative voting—A shareholder can accumulate all of his or her votes and vote them

when acting on behalf of the corporation.

 Duty of loyalty—A duty that directors and officers have not to act adversely to the

interests of the corporation and to subordinate their personal interests to those of the

corporation and its shareholders.

 Duty of obedience—A duty that directors and officers of a corporation have to act within

 Fiduciary duty—Duty of loyalty, honesty, integrity, trust, and confidence owed by

directors and officers to their corporate employers.

 Foreign Corrupt Practices Act (FCPA)—A federal statute that makes it a crime for U.S.

companies, or their officers, directors, agents, or employees, to bribe a foreign official, a

foreign political party official, or a candidate for foreign political office, where the bribe

business activity.

 Inside director—A member of the board of directors who is also an officer of the

corporation.

 Limited liability—Liability that shareholders have only to the extent of their capital

contribution. Shareholders are generally not personally liable for debts and obligations of

the corporation.

conducting the corporation’s business.

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corporation.

 Piercing the corporate veil—A doctrine that says if a shareholder dominates a corporation

and uses it for improper purposes, a court of equity can disregard the corporate entity and

hold the shareholder personally liable for the corporation’s debts and obligations.

 Policy decisions—The board of directors is responsible for formulating policy decisions

that affect the management, supervision, control, and operation of the corporation.

 Quorum to hold a meeting of the shareholders—The required number of shares that must

be represented in person or by proxy to hold a shareholders’ meeting. The RMBCA

establishes a majority of outstanding shares as a quorum.

 Ratification—The acceptance by a corporation of an unauthorized act of a corporate

officer or agent.

 Right of inspection—A right that shareholders have to inspect the books and records of

the corporation.

 Right of first refusal—An agreement that requires a selling shareholder to offer his or her

shares for sale to the other parties to the agreement before selling them to anyone else.

 Sarbanes-Oxley Act of 2002—It requires public companies to establish and maintain

secret profit.

 Section 102(b)(7) of the Delaware Corporation Code—It permits Delaware corporations

to include in their certificate of incorporation an exculpatory provision to protect

 Self-dealing—If the directors or officers engage in purchasing, selling, or leasing of

 Shareholders—Owners of a corporation who elect the board of directors and vote on

fundamental changes in the corporation.

 Shareholders’ list—It contains the names and addresses of the shareholders as of the

record date and the class and number of shares owned by each shareholder.

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and vote on important or emergency issues, such as a proposed merger or amending the

articles of incorporation.

 Staggered terms—The RMBCA allows boards of directors that consist of nine or more

members to be divided into two or three classes (each class to be as nearly equal in

number as possible) that are elected to serve staggered terms of two or three years.

him- or herself.

 Voting trust—The shareholders transfer their stock certificates to a trustee who is

empowered to vote the shares.

 Voting trust certificate—A voting trust is an arrangement whereby shareholders transfer

their stock certificates to a trustee. In exchange, voting trust certificates are issued to the

shareholders.