1063
Unit Eight
Focus on Ethics:
Business Organizations
See Separate Lecture Outline System
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.
ADDITIONAL RESOURCES—
VIDEO SUPPLEMENTS
1064 INSTRUCTOR’S MANUAL TO ACCOMPANY BUSINESS LAW, TWELFTH EDITION
The following video supplements relate to topics discussed in this feature—
Business Law Digital Video Library
The Business Law Digital Video Library at www.cengage.com/blaw/dvl offers a variety of videos for group or
individual review. Clips on topics covered in this chapter include the following.
• Ask the Instructor
Corporation Formation: Going Public: What does it mean for a company to “go public”?—A privately held
company goes public by selling small fractional ownership interests, known as shares of stock, to the public for the first
time. This is usually done by way of an initial public offering, or IPO. Not all shares will thereafter qualify to be traded
on public exchanges.
• Real World Legal
trusted bartender, suggesting a deal that will benefit them both. The bartender subsequently shares the information
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.
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. A corporate officer improperly usurps a corporate opportunity by, for example, setting up a competing
company to take advantage of an opportunity that might have otherwise been utilized by his or her company. A
corporate officer or director also has a duty to disclose improper conduct to the corporation. The test discusses a
recent case.
UNIT EIGHT: FOCUS ON ETHICS—BUSINESS ORGANIZATIONS 1065
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.
IV. The Sarbanes-Oxley Act and Insider Trading
The Sarbanes-Oxley Act of 2002 requires attorneys to report any material violations of securities laws to the
corporation’s highest authority. The Securities and Exchange Commission (SEC) requires attorneys whose corporate
clients are violating securities laws to publicly withdraw from representing the corporation and notify the SEC. This has
been controversial as a potential breach of attorney-client confidentiality. The American Bar Association changed its
ethics rules to allow an attorney to report a client’s possible fraud, but not all state ethics codes have followed suit.
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 concern itself with
nonlegal ethical considerations? If the firm’s officers attempt to operate the company so that it conforms with
ue?
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
1066 INSTRUCTOR’S MANUAL TO ACCOMPANY BUSINESS LAW, TWELFTH EDITION
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 information 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?
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 poten-
tial 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
2. Would a failure to disclose a potential corporate opportunity after the company had a reasonable period of
time to discover the opportunity entail liability? The cases would appear to require disclosure as long as the director
3. Does the duty of care arise from ethical considerations? Although the duty of care certainly has ethical overtones,
4. Should a court intervene when a board makes an unethical—though lawful—decision? Given the traditional
5. Are hostile takeovers inherently unethical? Although many persons believe that hostile takeovers should be
6. Should courts intervene when minority members of an LLC (or minority shareholders of a corporation) receive
what they believe to be unfair treatment at the hands of the majority members (or shareholders)? To protect the
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
8. Is SEC Rule 10b-5 fair? Should insider trading be allowed? The ethical assumption underlying the prohibition
1068 INSTRUCTOR’S MANUAL TO ACCOMPANY BUSINESS LAW, TWELFTH EDITION
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 DISCUSSION 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
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.
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.
include a regulatory disclaimer to avoid problems with the SEC. This ended his spontaneous, personal, and informal
4. Should corporate lawyers who become aware that someone at the client corporation may have violated
securities laws report their suspicions only to persons within the corporation, or should they report their
concerns to the SEC? Explain. Like the rest of us, attorneys are required to follow the law. In the case of attorneys,
the expectation is that they will do more than follow the letter of the law and adhere to its spirit as well. But the law is
not always more clear to attorneys than it is to laypersons. And the course that an attorney may be required to follow
can be more circuitous than it is for others. The fact situation stated in this question provides a prime example.
break confidence with a client to report possible corporate fraud, not all state ethics codes allow attorneys to disclose