978-1285770178 Lecture Note Unit 1

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INTRODUCTION

Because all business activities take place in one of the types of business organizations discussed within this

unit, all ethical issues relate, in one way or another, to the relationships that exist within these forms of business

organization. In this Focus on Ethics, selected areas are examined in which ethical problems relate to the specific

form in which business takes place—particularly, partnerships and corporations—and in the context of recent events

in the news and in the law.

FOCUS OUTLINE

I. The Emergence of Corporate Governance

The excess in some corporate executives’ conduct and compensation has come to light recently. Their

behavior and pay can contrast sharply with their firms’ earnings and success. Corporate governance controls

are meant to ensure that officers receive only the benefits they earn and that their actions are in the best

interests of the company.

2 INSTRUCTOR’S MANUAL TO ACCOMPANY BUSINESS LAW, THIRTEENTH EDITION

II. Fiduciary Duties Revisited

A. THE DUTY OF LOYALTY

Personal interests may conflict with the interests of a partnership or corporation with which an individual

is affiliated.

1. Acquiring Assets

A corporate officer improperly usurps a corporate opportunity by, for example, purchasing an asset

that might have otherwise benefited his or her company without first offering the opportunity to the

company.

2. Disclosure

A corporate officer or director also has a duty to disclose improper conduct to the corporation.

B. THE DUTY OF CARE

Corporate directors may have a duty to detect wrongdoing within their corporation. Further, under

corporate sentencing guidelines, courts may impose substantial penalties on corporations and directors

for criminal wrongdoing. Penalties may be mitigated if a company can show that it has in place an

effective program to detect and prevent wrongdoing by corporate personnel.

C. FIDUCIARY DUTIES TO CREDITORS

Directors’ duties of care and loyalty may extend to corporate creditors, and others who “sustain the

corporate entity,” if the corporation approaches insolvency.

III. Corporate Blogs and Tweets and Securities Fraud

Corporations that use the Internet to distribute information about themselves to investors must comply with

Securities and Exchange (SEC) regulations. For purposes of federal securities laws, the SEC regards

statements via online media—including blogs and tweets—that same as those communicated by other

means.

A. “TWEETS” THAT CONTAIN FINANCIAL INFORMATION

Corporate blogs sometimes link to employees’ Twitter accounts. Through the tweets that follow,

recipients get updates from, and can respond to, the individuals who post information. These blogs and

tweets must be phrased to avoid problems with the SEC.

B. THE SEC PROVIDES GUIDANCE

An SEC interpretive release reiterated an embrace of new technology, but pointed out that posting

information on a company’s Web site may be “a sufficient method of public disclosure.” Other Web

features—blogs, forums, and so on—can be useful for ongoing communications with investors and other

stakeholders. But all communications by or on behalf of a company—as well as statements on linked

third-party sites—are subject to federal securities laws. Recipients cannot waive these protections.

TEACHING SUGGESTIONS

1. Ask the class to discuss the extent to which ethical considerations guide the conduct of corporations and

other forms of business organizations. Must a business firm that is operating in a lawful manner

UNIT EIGHT: FOCUS ON ETHICS—BUSINESS ORGANIZATIONS 3

concern itself with nonlegal ethical considerations? If the firm’s officers attempt to operate the

company so that it conforms with certain ethical standards that

impose costs far in excess of those required to operate the corporation in a lawful manner, would

such conduct constitute a breach of duty to the firm’s owners who will ultimately suffer from the

firm’s reduced value?

2. Dayton Hudson Corporation (now Target Corporation) regularly contributed 5 percent of pretax profits to

charities. When an outside firm considered a takeover of Dayton Hudson, the legislature of Minnesota (the

state in which Dayton Hudson was incorporated) convened in a special session and passed a tough new

antitakeover law. The outside firm dropped the idea of taking over the Minnesota company. It was suggested

that Dayton Hudson management was more interested in protecting their jobs than in rewarding shareholders,

whose money it was, of course, that was given to charities. It was also said that donating a small percentage

of pretax profits to charity was “a small price to pay for owning a legislature.” Ask students to discuss the

motivations behind corporate gifts to charities. Is such behavior prompted by ethical considerations? Is

it even ethical for corporations to get involved in philanthropic activities absent explicit approval by

the shareholders?

3. Have students consider a hypothetical in which an investor does not actually possess any inside in–

formation but pretends that he or she does, and profits from a sale of stock to a buyer who believes the

misrepresentation. What law might the investor violate? What must be proved to show a violation?

What ethical duty might this situation involve?

4. Another possible situation to consider is whether a franchisor should be held liable for the torts of a

franchisee’s employees. On what should liability depend? If a franchisor’s control over the operations

of the franchisee is extensive, should the franchisor be held liable? On what theory? There are cases

in which franchisees were held to be employees, despite clauses in their franchise contracts designating the

franchisees to be independent contractors.

Cyberlaw Link

What ethical duties might an investor violate by going online, into chat and discussion groups, to

tout units in an LLC (or corporate stock) that the investor owns in an attempt to inflate the price so

the investor can make a profit from its sale?

How can the interests of franchisees be protected in the context of the Internet? Does the Federal

Trade Commission’s Franchise Rule address this question sufficiently?

ADDITIONAL QUESTIONS

1. Does the duty of loyalty owed by a director to his or her corporation require that the director disclose

a potential business opportunity to the corporation or merely wait a reasonable time until the corporation has

had the opportunity to discover the opportunity for itself? The requirement of disclosure would appear to come

into play only if the director is personally interested in taking advantage of the corporate opportunity. If the director

4 INSTRUCTOR’S MANUAL TO ACCOMPANY BUSINESS LAW, THIRTEENTH EDITION

2. Would a failure to disclose a potential corporate opportunity after the company had a reasonable pe-

riod of time to discover the opportunity entail liability? The cases would appear to require disclosure as long as

3. Does the duty of care arise from ethical considerations? Although the duty of care certainly has ethical

overtones, it is primarily a legal concept by which directors and officers are held to certain standards of conduct that

they must meet in order to avoid liability. Whether a director’s good faith decisions can also be said to be ethical may

4. Should a court intervene when a board makes an unethical—though lawful—decision? Given the tradi–

tional deference of the courts to boards of directors regarding the conduct of corporate affairs, the courts will be

reluctant to become involved in such matters absent evidence of fraud, bad faith, abuse of discretion or gross

5. Are hostile takeovers inherently unethical? Although many persons believe that hostile takeovers should

be prohibited due to their disruptive effects on target companies, it is unclear whether they are inherently unethical.

The answer may depend on who is benefited by a hostile takeover. If the company is poorly managed and the hostile

6. Should courts intervene when minority members of an LLC (or minority shareholders of a corpora–

tion) receive what they believe to be unfair treatment at the hands of the majority members (or shareholders)?

To protect the interests of minority owners, courts have shown an increasing willingness to allow minority corporate

shareholders to sue majority shareholders directly for breach of fiduciary duties. Some courts have also ordered close

7. When “negative opinions” about a company cause its price to drop, does the company have recourse

against those expressing and propagating those opinions in online chat rooms? Such statements are not likely

to constitute a basis for liability. Defamation of a publicly traded company, for example, requires a false statement of

fact made with malice that causes damage. Statements of opinion are not actionable. the context and format of the

8. Is SEC Rule 10b-5 fair? Should insider trading be allowed? The ethical assumption underlying the

prohibition against insider trading is that corporate insiders should not have advantages in the securities trading arena

that the general public does not. If insider trading were legal, more insiders would have bought, for example, Texas

UNIT EIGHT: FOCUS ON ETHICS—BUSINESS ORGANIZATIONS 5

ACTIVITY AND RESEARCH ASSIGNMENT

Ask each student to prepare a brief report on a notorious incident involving insider trading. Special attention

should be devoted to how the trading activities were carried out and ultimately detected, as well as the consequences

that followed from the incident.

BUSINESS ORGANIZATIONS—

 ANSWERS TO LEGAL REASONING QUESTIONS 

1. Three decades ago, corporations and corporate directors were rarely prosecuted for crimes, and

penalties for corporate crimes were relatively light. Today, this is no longer true. Under the corporate

sentencing guidelines and the Sarbanes-Oxley Act, corporate wrongdoers can receive substantial

penalties. Do these developments mean that corporations are committing more crimes today than in

the past? Will stricter laws be effective in curbing corporate criminal activity? How can a company

avoid liability for crimes committed by its employees? No, these developments do not mean that

corporations are more criminal than in the past. It is more likely that crime is perpetually ongoing. But every

now and then, scandals in the business world rock the nation. This has been the situation in recent years.

And, as noted in several chapters in this unit, Congress responded to public outcry by passing the Sarbanes–

Oxley Act in 2002, imposing stricter requirements on corporations with respect to accounting practices and

statements made in documents filed with the Securities and Exchange Commission (SEC)..

The lesson that Congress intended for the business world is, of course, that if business leaders do not

behave ethically (and legally), the government will create new laws and regulations that force them to do so. It

is always the hope that stricter laws will be effective in deterring criminal activity. Whether this occurs in the

corporate context as a consequence of the enactment of new laws with stricter penalties remains to be seen.

In other contexts, reductions in crime have been brought about through a variety of means—punishing the

smallest infractions, for example, has sometimes deterred more serious crimes, and treatment for addiction

has often deterred more crimes than incarceration. What methods would work in a corporate context might

require first pinpointing the motivations for corporate crimes and tracking their course.

One of the surest ways for a company to avoid liability for crimes committed by its employees is to

prevent the commission of such crimes in the first place. As suggested in the previous paragraph, a

corporation might refuse to broach the smallest violation of company rules. The firm might impose and

enforce check and double-check routines—in the handling of corporate funds, for example—that would be

likely to catch any criminal activity before it succeeds. Such corporate controls could ensure that employees

receive the benefits they earn, but only the benefits they earn. This also helps to ensure that the actions taken

by the employees are in the best interests of the company. In this way, the corporation can be confident that it

is at least acting ethically toward its shareholders. And criminal penalties can be mitigated if a company can

show that it has an effective compliance program in place to detect and prevent wrongdoing by corporate

personnel.

6 INSTRUCTOR’S MANUAL TO ACCOMPANY BUSINESS LAW, THIRTEENTH EDITION

2. Do you agree that when a corporation is approaching insolvency, the directors’ fiduciary

obligations should extend to the corporation’s creditors as well as to the shareholders? The answer to

this question, according to some courts, is yes. In a leading case on this issue, discussed in the text, one

state court noted that “the possibility of insolvency can do curious things to incentives, exposing creditors to

risks of opportunistic behavior and creating complexities for directors.” The court held that when a

corporation is on the brink of insolvency, the directors assume a fiduciary duty to other stakeholders that

sustain the corporate entity, including creditors.

Of course, it is a long-standing principle that corporate directors ordinarily owe fiduciary duties only to a

corporation’s shareholders. In some cases, in other circumstances, directors who favored the interests of

other corporate “stakeholders,” such as creditors, over those of the shareholders have been held liable for

breaching these duties.

The picture changes, however, when a corporation approaches insolvency. This is because at that point,

the shareholders’ equity interests in the corporation may be worthless, while the necessity to recognize the

interests of creditors becomes acute. Thus, when a corporation is insolvent, courts have sometimes required

directors to consider the best interests of the whole corporate enterprise—including all its constituent groups.

The directors have been charged to maintain a balance among those interests, however, and not to give a

preference to the interests of any one group.

3. When a company’s executives offer opinions about the firm’s financial status and future business

prospects through blogs, Twitter, and other Internet forums, the SEC can hold the company liable for

violating securities laws. Is this fair to investors who want to hear the straight scoop from the firm’s

executives? What arguments can you make in favor of this restriction? What arguments can you

make against it? Corporations that use the Internet to distribute information about the company to investors,

however, need to make sure that they comply with the regulations issued by the SEC. The SEC treats

statements by employees on online media, such as blogs and Twitter, the same as any other company

statements for purposes of federal securities laws.

In favor of this enforcement, one might point to the SEC release outlined in the text. The SEC generally

embraces new technology and encourages companies to use electronic communication methods. But the

SEC also emphasizes that “while blogs or forums can be informal and conversational in nature, statements

made there . . . will not be treated differently from other company statements.” Companies cannot require

investors to waive protections under federal securities laws as a condition of participating. Further, companies

in some situations can be liable for providing hyperlinks to third party information or inaccurate summaries of

financial information on their Web sites. Like the securities laws generally, these restrictions help to deter

fraud. Besides, as the SEC adds, “the use of the Internet has grown such that, for some companies in certain

circumstances, posting of the information on the company’s Web site, in and of itself, may be a sufficient

method of public disclosure.”

In opposition to this enforcement, one might point to the case of Richard Brewer-Hay, who is noted in the

text. Corporate blogs sometimes include links to corporate employees’ Twitter accounts so that readers can

communicate directly with, and get updates from, the individual who posted the information. eBay, Inc., hired

Brewer-Hay to report through its blog and tweet updates about the company’s earnings and activities. Brewer–

Hay was soon required to include a regulatory disclaimer to avoid problems with the SEC. This ended his

spontaneous, personal, and informal style, and he began to often simply repeat eBay executives’ statements

verbatim. Many of his followers were disappointed. In other words, the enforcement of tight restrictions can

whole or in part.