978-1285860381 Chapter 35 Solution Manual Part 2

Unlock access to all the studying documents.

View Full Document

Additional Case: Michael L. Retzer v. Nancy B. Retzer1

Facts: Mr. Retzer worked long hours to acquire five McDonald’s franchises. He owned 1,610 shares of

stock in the close corporation that owned the franchises; his wife had 1,600 shares. Mrs. Retzer was

unfaithful and a profligate spender. The couple divorced.

Issue: What are Mr. Retzer’s obligations to Mrs. Retzer as a minority shareholder?

Holding: Because of her adultery, Mrs. Retzer would not be entitled to any alimony. However, she

was entitled to a fair return as a shareholder and Mr. Retzer owed her a fiduciary duty. The court

promised that it would closely scrutinize Mr. Retzer’s conduct.

Question: What did Mr. Retzer owe Mrs. Retzer for alimony?

Question: What is Mr. Retzer’s duty to Mrs. Retzer as a shareholder of the company?

Question: Is the result in this case fair?

Answer: Although students often begin by saying that the case is not fair, they ultimately

Example: The Sinven Case2

Sinclair Oil owned 97 percent of Sinven. Sinven’s minority shareholders complained that Sinclair:

Forced Sinven to pay dividends so large that the subsidiary faced bankruptcy,

Hired other, wholly owned subsidiaries but not Sinven, and

Refused to force its other subsidiaries to abide by their contracts with Sinven. For instance, a

Sinclair subsidiary signed a contract with Sinven to buy crude oil but failed to purchase the

required amount.

Question: Was it fair for Sinclair to force Sinven to pay dividends so large that it faced bankruptcy?

Question: Was it fair for Sinclair to hire other, wholly owned subsidiaries rather than Sinven?

Question: Was it fair for Sinclair not to force its other subsidiaries to abide by their contracts with

Sinven?

Enforcing Shareholder Rights

Derivative Lawsuits

Shareholders bring a derivative lawsuit to remedy a wrong to the corporation. The suit is brought in

the name of the corporation and all proceeds of the litigation go to the corporation.

1 578 So. 2d 580, 1990 Miss. LEXIS 858 Supreme Court of Mississippi, 1990

2 Sinclair Oil Corp. v. Levien, 280 A.2d 717, 1971 Del. LEXIS 225 Supreme Court of Delaware, 1971

Case: In re eBay, Inc. Shareholder Litigation3

Facts: Pierre M. Omidyar and Jeffrey Skoll founded eBay, Inc. a company that hosts an online auction

site. Later, Robert C. Kagle and Margaret C. Whitman joined the eBay board. Whitman also became

president and CEO. Goldman Sachs Group Inc. twice served as lead underwriter when eBay sold

shares to the public. Then Whitman became a director of Goldman. Afterwards, Goldman served as

eBay’s financial advisor when it acquired PayPal, Inc.

During this period in which Goldman engaged in three major transactions with eBay, the

investment bank also served as underwriter for a substantial number of technology companies that

went public. Many investors wanted to buy stock in these initial public offerings (IPOs) because an

immediate and large profit was virtually guaranteed. Often stock prices doubled or tripled on the day of

the offering. Goldman allowed Omidyar, Skoll, Kagle, and Whitman, all directors of eBay, to buy

shares in hundreds of its IPOs, effectively giving them millions of dollars in profits. The following

chart reveals the percentage of eBay shares that each director owned and the number of Goldman IPOs

in which he or she was allowed to invest:

In each case, the eBay directors sold the stock immediately for millions of dollars in total profit.

eBay shareholders sued, alleging that Goldman had effectively bribed the defendants to continue

giving business to the bank. The lawsuit was brought as a derivative action in the name of eBay. The

plaintiffs alleged that demand was futile because the directors had a conflict of interest.

eBay’s board of directors had seven members: Omidyar, Kagle, Whitman, Philippe Bourguignon,

Scott D. Cook, Dawn G. Lepore, and Howard D. Schultz. (At the time of the lawsuit, Skoll was no

longer a director.) The court determined that the three defendants had a conflict of interest because they

were the targets of the lawsuit. It was obvious they would not vote for eBay to pursue the litigation. If

one of the remaining four directors also had a conflict, then that would constitute a majority and

demand would be excused. The shareholders could then proceed with the lawsuit.

Issue: Did a majority of the board of directors have a conflict of interest? Was demand on the board

futile?

Holding: Judgment for the shareholders.

Excerpts from Chancellor Chandler’s Decision: Plaintiffs allege that Cook, Lepore, Schultz, and

Bourguignon have received huge financial benefits as a result of their positions as eBay directors and,

furthermore, that they owe their positions on the board to Omidyar, Whitman, Kagle, and Skoll.

[I]n 1998, when Cook joined eBay’s board, it awarded him 900,000 [stock] options. In 1998, eBay

adopted a director’s stock option plan pursuant to which each non-employee director was to be

awarded 30,000 options each year. [T]he stock options are worth potentially millions of dollars.

I need not address each of the four outside directors, as I agree with plaintiffs that the allegations

of the complaint are sufficient to raise a reasonable doubt as to Cook’s independence from the eBay

insider directors who accepted Goldman Sachs’ IPO allocations.

First, Whitman, Omidyar, Kagle, and Skoll (and their affiliates) own about one-half of eBay’s

outstanding common stock. As a result, these eBay officers and directors effectively have the ability to

3 2004 Del. Ch. LEXIS 4 Court of Chancery of Delaware, 2004

control eBay and to direct its affairs and business, including the election of directors and the approval

of significant corporate transactions.

Second, a significant number of options have not yet vested and will never vest unless the outside

directors remain directors of eBay. [“Vested” means that the owner is allowed to keep the options, even

if he leaves the company.] Given that the value of the options for Cook (and allegedly for the other

outside directors) potentially run into the millions of dollars, one cannot conclude realistically that

Cook would be able to objectively and impartially consider a demand to bring litigation against those

to whom he is beholden for his current position and future position on eBay’s board. With the specific

allegations of the complaint in mind, I conclude that plaintiffs have adequately demonstrated that

demand on eBay’s board should be excused as futile.

Update: Meg Whitman and the two other company officials agreed to pay $3 million to settle this suit.

Question: What is a derivative suit?

Question: Why would anyone want to do that?

Question: Why can’t they simply file a direct lawsuit?

Answer: The theory is that, if the corporation is injured, all shareholders suffer the same injury

Question: Why would any shareholder file suit if recovery goes to the corporation?

Answer: If the corporation loses, it must pay the legal fees of the victorious plaintiffs. Most

Question: Are there any circumstances under which a shareholder can bring a direct action

against the company?

Answer: Only if the shareholder has some “special injury.” This means that either:

Question: Can you give an example?

Answer:

If the corporation refuses to repay a loan to one shareholder, she can file a direct action against

If the corporation refuses to pay dividends that it is obligated to pay, the corporation is not

Question: Could the shareholders have filed a direct lawsuit in this case?

Question: What was the injury to the corporation?

Question: Did they make money?

Question: How did this harm eBay?

Question: What did the court hold?

Question: What happened next?

Question: Some of the defendants in this case were billionaires. Why would they take stock from

Goldman?

Question: What would the ethics checklist have revealed to them?

Multiple Choice Questions

1. A majority of shareholders at Weed, Inc. wanted to reinstate the former CEO of the company and sell

off an unprofitable division. Do shareholders have the right to make these two decisions?

(a) Yes to both.

(b) No to both.

president.

(d) The shareholders have the right to reinstate the president but not to sell off an unprofitable

division.

2. Companies are NOT required to_______.

(a) disclose the relationship between financial performance and executive compensation

(b) disclose the ratio between the CEO’s total compensation and the median total compensation for

all other company

(d) establish a clawback policy

3. A company is allowed to hold its annual meeting online______.

(a) if a majority of its shareholders approve

(b) if it also hold a live meeting for shareholders who want to attend in person

(d) any way it wants, as long as shareholders are notified

4. By law, a candidate for the board of a publicly traded company must_______.

(a) receive a majority of the votes cast

(b) receive a majority vote of the shares outstanding

(d) receive a plurality of the shares outstanding</EOCMULTA>

5. If directors and officers cause harm to their company,________.

(a) Shareholders have the right to file suit against them and recover damages

(b) shareholders have the right to file suit against them and recover damages only if the board

permits the suit

permits the suit or a court deems the demand futile

(d) shareholders do not have the right to file suit against them

Case Questions

1. Pfizer Inc. paid $2.3 billion to settle civil and criminal charges alleging that it had illegally

marketed 13 of its most important drugs. This settlement made history, but not in a good way. It

was both the largest criminal fine and the largest settlement of civil health care fraud charges ever

paid. Shareholders filed a derivative suit against the Pfizer board and top executives. Defendants

responded with a motion to dismiss on the grounds that shareholders had not made demand on the

board. Was demand necessary?

Answer: The court excused demand because the Complaint alleged “misconduct of such

pervasiveness and magnitude, undertaken in the face of the board’s own express formal

2. William H. Sullivan, Jr., purchased all the voting shares of the New England Patriots Football Club,

Inc. (the Old Patriots). He organized a new corporation called the New Patriots Football Club, Inc.

The boards of directors of the two companies agreed to merge. After the merger, the nonvoting

stock in the Old Patriots was to be exchanged for cash. Do minority shareholders of the Old

Patriots have the right to prevent the merger? If so, under what theory?

Answer: The Supreme Judicial Court of Massachusetts held that “the defendants bear the burden

of proving, first, that the merger was for a legitimate business purpose, and second, that,

3. ETHICS Edgar Bronfman, Jr., dropped out of high school to go to Hollywood and write songs

and produce movies. Eventually, he left Hollywood to work in the family business—the Bronfmans

owned 36 percent of Seagram Co., a liquor and beverage conglomerate. Promoted to president of

the company at the age of 32, Bronfman seized a second chance to live his dream. Seagram

received 70 percent of its earnings from its 24 percent ownership of DuPont Co. Bronfman sold this

stock at less than market value to purchase (at an inflated price) 80 percent of MCA, a movie and

music company that had been a financial disaster for its prior owners. Some observers thought

Bronfman had gone Hollywood, others that he had gone crazy. After the deal was announced, the

price of Seagram shares fell 18 percent. Was there anything Seagram shareholders could do to

prevent what to them was not a dream but a nightmare? Apart from legal issues, was Bronfman’s

decision ethical? What ethical obligations does he owe Seagram’s shareholders?

Answer: The Seagram shareholders have little choice other than the “Wall Street walk.” Seagram

will not merge with MCA, so shareholder approval of the purchase is not necessary. The sale of

4. You Be the Judge: WRITING PROBLEM Two shareholders of Bruce Co., Harry

and Yolan Gilbert, were fighting management for control of the company. They asked for

permission to inspect Bruce’s stockholder list so that they could either solicit support for their slate

of directors at the upcoming stockholder meeting, or attempt to buy additional stock from other

stockholders, or both. Bruce’s board refused to allow the Gilberts to see the shareholder list on the

grounds that the Gilberts owned another corporation that competed with Bruce. Do the Gilberts

have the right to see Bruce’s shareholder list? Argument for the Gilberts: If shareholders of a

company have a proper purpose, they are entitled to inspect shareholder lists. Soliciting votes and

buying stock are both proper purposes. Argument for Bruce: The Gilberts are simply offering a

pretext. They could use this information to compete against the company. No shareholder has the

right to cause harm.

Answer: If the admitted purpose of inspection is one directly related to the Gilberts’ status as

stockholders and is not an unlawful or improper purpose, then the Gilberts have the right to see the

5. Shareholders lost their gamble when they bought stock of Jackpot Enterprises, Inc. Fed up with

management, a shareholder asked the company to include a proposal in the proxy statement that

would require the board of directors to sell or merge the company. Must Jackpot include this

proposal in its proxy statement?

Discussion Questions

1. Corporate executives are not the only people to earn fabulous salaries. Some athletes earn even

more than CEOs. What is the difference between athletes and executives (besides a hook shot)?

Answer: Athletes’ salaries are negotiated at arm’s length with the team owner who will actually be

2. DeVry Inc. runs for-profit schools. Its shareholders submitted a proposal that would require the

company to “annually report to shareholders on the expected ability of students at Company-owned

institutions to repay their student loans.” Must DeVry include this proposal in its proxy material

for its annual meeting?

Answer: The SEC ruled that DeVry could exclude this proposal because it relates to the

3. ETHICS After a recent annual meeting, Cisco Systems reported the results of the votes on both

management and shareholder proposals. The company reported the results of its own proposals as a

simple ratio of those in favor divided by the total number of votes cast. But for shareholder

proposals, it reported the percentage as a ratio of those in favor divided by all outstanding shares.

As a result, it reported the favorable vote for one shareholder proposal as 19% when, in fact, 34%

of the votes cast supported this proposal. Is Cisco behaving ethically?

4. For several years, CSK Auto, Inc. fraudulently reported inflated earnings. During this period,

Maynard Jenkins was CEO. He was not, however, involved in the fraud and was never charged

with a crime. Nonetheless, using a SOX provision, the SEC sought to claw back some of his

earnings during this period. Should Jenkins be financially responsible for fraud that occurred on his

watch even though he did not participate?

5. Would the following initiatives improve corporate governance? Can you think of others that

would?

(a) Require the board of directors to implement shareholder proposals that receive a majority vote

(b) Require proxy access

cast

(d) Base compensation on net returns on invested capital

(e) Make say-on-pay votes binding