3rd Conference: Legal Duties Responsibilities Corporate Directors Controlling Persons

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LEGAL DUTIES AND RESPONSIBILITIES OF CORPORATE DIRECTORS AND CONTROLLING
PERSONS OF U.S. PUBLICLY-OWNED COMPANIES

Andres V. Gil [FNa1]

INTRODUCTION

This article outlines the legal duties and responsibilities of corporate
directors and controlling persons [FN1] of U.S. publicly-owned companies. Its
purpose is to provide a general understanding of the legal duties involved in
serving as a director or in being a controlling person and to provide practical
guidance in performing such duties.
To that end, this article is divided into three main sections. The first
section outlines general duties and responsibilities imposed by basic
principles of law in the United States on corporate directors. The second
section outlines more specific duties and responsibilities imposed by the
federal securities laws. Finally, the third section attempts to provide some
guidelines for performance of the duties outlined in the first two sections.
It should be noted, however, that in the United States the laws prescribing
the duties and liabilities of corporate directors and controlling persons
include a combination of state and federal statutes and court decisions. The
business laws of a given state where a corporation is formed will, in most
cases, govern the conduct of its directors and controlling persons. The federal
securities laws also impose specific requirements upon public company directors
and controlling persons. In addition, each state has its own laws governing
sales of corporate securities within that state which must be observed.
Due to the existence of these various sources of legal principles which may
differ among jurisdictions, this article undertakes to deal with broad areas of
concern and attempts to provide legal standards and principles common to the
majority of jurisdictions. It does not purport to state exact solutions to
particular problems. Corporate directors and controlling persons are urged to
seek advice on both general and particular matters from their corporation's
legal advisors and their own legal counsel.

*2 I. GENERAL DUTIES AND RESPONSIBILITIES

A. Standard of Care

The legal obligations of directors fall into two broad categories: a duty of
loyalty and a duty of care (including a duty to be attentive to the
corporation's business). In exercising such obligations the directors may rely
on information provided by management or advisors, and decisions duly made by
such directors may be protected under the "business judgment rule." [FN2] The
directors may also be indemnified in certain circumstances when they are made a
party to litigation by reason of their role as directors. [FN3]

1. Duty of Loyalty
By assuming office, the corporate director commits allegiance to the
enterprise and acknowledges that the best interests of the corporation and its
shareholders must prevail over any personal, individualized interest. The basic
principle to be observed is that the director should not use his corporate
position to make a personal profit or gain other personal advantage. As a
practical method of complying with the duty of loyalty, many directors have
adopted the practice of absenting themselves from that portion of a board
meeting during which matters which concern them personally are considered. The
duty of loyalty is manifested by certain particularized legal concepts,
discussed below.

a. Conflict of Interest
When the corporate director has a material personal interest in a contract or
transaction to which the corporation is to be a party (either directly or
indirectly, because of an employment or investment relationship with an entity
with which the corporation is dealing or otherwise) the director should
disclose the existence of such interest, and describe the nature thereof (e.g.,
financial, family relationship, professional or business affiliation, etc.) to
the other directors prior to the time action is taken by the board with respect
to the matter and, further, he should abstain from acting thereon. [FN4] In
addition, the interested director should be aware that appropriate voting and
quorum requirements must be met. [FN5] Under prevailing practice, but with
significant exceptions in some states, [FN6] the *3 interested director may
be counted in determining the presence of a quorum but his vote of consent may
not be counted for purposes of the requisite action. [FN7]

b. Duty of Fairness
When conflicting interests are present, the corporate director must be
concerned that fairness obligations are recognized and satisfied. If a
transaction by a director with the corporation involves a possible conflict of
interest, fairness to the corporation should be a primary concern for both the
interested director and those disinterested directors entertaining a request
for favorable action. [FN8] The standard commonly used involves ascertainment
that the proposed transaction is on at least as favorable terms to the
corporation as might be available (assuming appropriate comparability) from any
other person or entity. [FN9] If minority shareholders may be adversely
affected, all directors should be concerned with the fairness of their
treatment. This concern is heightened in instances where a dominant shareholder
or shareholder group has a divergent conflicting interest known to the
corporate director.

c. Corporate Opportunity
When an opportunity (commonly referred to as a "corporate opportunity") to
acquire another business enterprise, to acquire property, to license patents or
inventions, to market new products, or to seize any other business advantage
comes to the attention of the corporate director as a result of his relation to
the corporation in a way that would permit its personal realization, and is
relevant to the enterprise's present or prospective business activities, the
director must first present it to his corporation. [FN10] Only after informed
evaluation and a determination (by disinterested peers) that the corporation
should not pursue such corporate opportunity, should the corporate director
pursue the matter for his own account or for the benefit of others. [FN11] If
an individual encounters a corporate opportunity which may be of interest to
more than one corporation which he serves as a director, complicated and
difficult conflict questions may be presented.

d. Confidentiality
The director should deal in confidence with all matters involving the
corporation until such time as there has been a general public disclosure
*4 or unless he knows that particular information is a matter of public
record or is a matter of common knowledge. This presumption of a need for
confidential treatment should apply regarding all current information
concerning board or corporate activities. The importance of confidentiality
cannot be overemphasized, not only because of financial exposure for both the
corporation and the individual under the federal securities laws in the event
of improper use of so-called "inside information," [FN12] but also because of
the potential for jeopardy to the enterprise in terms of competitive
disadvantage. [FN13]

2. Duty of Care
In addition to owing a duty of loyalty to the corporation, the corporate
director also assumes a duty to act carefully in fulfilling the important tasks
of monitoring and directing the activities of corporate management. The Model
Business Corporation Act sets forth the legal standard as follows:
[a] director shall discharge his duties as a director, including his duties
as a member of a committee: (1) in good faith; (2) with the care an
ordinarily prudent person in a like position would exercise under similar
circumstances; and (3) in a manner he reasonably believes to be in the best
interests of the corporation. [FN14]
The corporate director also has a responsibility to participate actively in
the oversight of the enterprise's activities. Regular attendance at meetings of
the board of directors and board committees is an obvious requirement for
acceptable director performance. In preparation for such meetings, the
corporate director should be furnished with appropriate information regarding
every important matter requiring board actions; in every case, there should be
available to the corporate director sufficient information furnished in time so
as to permit an informed judgment. If for any reason sufficient information is
not made appropriately available, the corporate director should request that
action be delayed until the information is made available. If action is
nonetheless taken, the corporate director should at a minimum request that his
abstention, and reason therefor, be recorded in the minutes of the meeting.
Under these circumstances, he should consider the need for his resignation.
Once documents are provided, the corporate director is expected to read the
material distributed to members of the board. Depending upon the individual's
role (e.g., committee membership or chairmanship), more detailed analysis may
be required.
*5 It is both permissible and expected that the corporate director will
delegate to others (including a board committee) some functions traditionally
associated with board activity; however, the delegator has a responsibility to
keep informed as to the activities of the delegatee. The extent of this
monitoring function (which is distinct from the ongoing monitoring of
management's performance) will vary depending upon the nature and importance of
the delegation, and will be satisfied in the usual case by receipt of periodic
reports concerning the activities of the delegatee.

3. Reliance
The Model Business Corporation Act expressly endorses the concept of
reliance, and this codification of a somewhat diffused common law standard has
been adopted or is under active consideration by a number of states:
In discharging his duties a director is entitled to rely on information,
opinions, reports, or statements, including financial statements and other
financial data, if prepared or presented by:
(1) one or more officers or employees of the corporation whom the director
reasonably believes to be reliable and competent in the matters presented;
(2) legal counsel, public accountants, or other persons as to matters the
director reasonably believes are within the person's professional or expert
competence; or
(3) a committee of the board of directors of which he is not a member if
the director reasonably believes the committee merits confidence. [FN15]
The corporate director can make a valuable contribution through relevant
inquiry and discussion of management's proposals, and does not jeopardize the
protection intended to be afforded to him if he complements the "input" on
which he proposes to rely with questions and focused discussion. Moreover,
recurring mechanical reliance without critical analysis could place in question
the corporate director's exercise of informed judgment.

4. The Business Judgment Rule
Recognizing that, consistent with the business corporation's profit
orientation, business judgment inevitably involves risk evaluation and
assumption, and recognizing that the office of corporate director, as such,
does not require full time commitment to the affairs of the enterprise, the
corporate director frequently makes important decisions which may eventually
prove to be erroneous. A director exercising his good faith judgment may be
protected from liability to his corporation under the so-called "business
judgment rule." [FN16] While not part of the statutory *6 framework, this
legal concept is well established in the case law of most jurisdictions. [FN17]
When viewing the decisions of directors acting in the exercise of free and
independent judgment, courts have been extremely reluctant to find that the
directors acted negligently. [FN18] Recognizing that business decisions may
seem unrealistically simple when viewed with hindsight, and expressing
reluctance to substitute their judgment for that of directors, courts have
generally refrained from questioning the wisdom of board decisions. [FN19] For
the business judgment rule to apply, however, a director must have acted in
good faith and with a reasonable basis for believing that the action authorized
was in the lawful and legitimate furtherance of the corporation's purposes, and
must have exercised his honest business judgment after due consideration of
what he reasonably believed to be the relevant factors. [FN20] The business
judgment rule will not apply in situations where conflict of interest or other
breaches of the duty of loyalty are present. [FN21]

5. Indemnification
The Model Business Corporation Act sets out in detail the circumstances
in which there can be indemnification of a corporate director made a party to
litigation. [FN22] Such a suit might be brought by the corporation or by a
shareholder in the right of the corporation challenging the director's
performance of duties as a director (commonly called a "derivative action"),
[FN23] or by a governmental agency or private party for a breach of contract,
tortious conduct or violation of law (commonly called a "third party action").
[FN24] The Model Act provisions, which have been adopted by numerous states
(including Delaware), give the corporation power to indemnify directors in
third party actions against expenses (including attorneys' fees), judgments,
fines, and amounts paid in settlement of the action, and in derivative actions
against expenses, including attorneys' fees. [FN25]
The common standard for such indemnification is that the director must have
acted in good faith and in a manner he reasonably believed to be in (or not
opposed to) the best interests of the corporation [FN26] and, if a criminal
action or proceeding is involved, the director must also *7 have "had no
reasonable cause to believe his conduct was unlawful." [FN27] The
indemnification for expenses is automatic if the director has been successful
in the defense of any action, on the merits or otherwise. [FN28]
Indemnification is not mandatory under the customary bylaw provision where the
director is not successful. If the director meets his duties of loyalty and
care, however, it is likely that the standard of conduct required for
indemnification will also be met. In the case of settlements or certain adverse
court determinations in third party actions, indemnification is permitted upon
a determination by an appropriate independent majority of directors or
shareholders, or by independent legal counsel, that the director met the
applicable standard of conduct. [FN29]
It should be noted that the Securities Exchange Commission (SEC) has long
held the position that indemnification of directors for liability under the
1933 Securities Act [FN30] is contrary to public policy, and indemnification in
these circumstances would in all likelihood be subject to prior judicial
resolution of public policy considerations. [FN31]

B. Management and Protection of Corporate Assets
Directors are charged with responsibility for the management and protection
of corporate assets. [FN32] This area of responsibility is governed principally
by the laws of the state under which a corporation is formed. The statutes of
most states specifically provide that the business of the corporation shall be
managed by the board of directors and that directors are ultimately responsible
to the stockholders who elect them for actions or omissions in connection with
such management. [FN33] The Foreign Corrupt Practices Act [FN34] also charges
directors with accountability for corporate assets. [FN35] The assets of
employee benefit plans are very significant assets for which directors also
have responsibilities. [FN36]

1. Foreign Corrupt Practices Act
Accountability for corporate assets is covered by the Securities
Exchange Act of 1934 [FN37] as amended by the Foreign Corrupt Practices Act of
1977 (FCPA). [FN38] The FCPA not only prohibits bribing foreign officials and
*8 other persons in order to obtain business, [FN39] but also imposes on
United States companies the obligation to keep books, records and accounts
which "in reasonable detail, accurately and fairly reflect the transactions and
dispositions of" the company's assets. [FN40] The FCPA also requires that a
United States company devise and maintain a system of internal accounting
controls sufficient to provide reasonable assurances that (i) transactions are
executed consistent with management authorization; (ii) transactions are
recorded as necessary both to permit the preparation of financial statements in
conformity with generally accepted accounting principles or other applicable
criteria and to maintain accountability for assets; (iii) access to assets is
permitted only in accordance with management's general or specific
authorization; and (iv) the recorded accountability for assets is compared with
the existing assets at reasonable intervals and appropriate action is taken
with respect to any differences. [FN41] It seems reasonable to expect that the
Commission, vested with responsibility for enforcement (along with the
Department of Justice, to which it may recommend criminal prosecutions) of this
authority under the 1934 Act, will proceed vigorously where it believes the
FCPA has been violated as part of a scheme to conceal an improper payment or
otherwise prevent the detection of misconduct within the corporation. It is
important to note the SEC's position (which has support in the legislative
history of the FCPA) that it is not necessary to prove corrupt or criminal
intent in order to bring an action to enjoin conduct which violated the FCPA.
[FN42]
Subsequent to enactment of the FCPA, the SEC adopted Regulation 13b-2 under
the 1934 Act. [FN43] Rule 13b2-1 prohibits any person from directly or
indirectly falsifying or causing to be falsified "any book, record or account
subject to Section 13(b)(2)(A)" of the 1934 Act. [FN44] The SEC determined that
although this Rule was not directed solely to the problem of questionable or
illegal payments and practices, its adoption "should serve to discourage a
repetition of the serious abuses the Commission has uncovered." [FN45] Rule
13b2-2 applies to officers and directors of the corporation and prohibits the
making or causing to be made of "a materially false or misleading statement"
[FN46] or failing to state material facts to an accountant in connection with
the audit of the corporation's financial statements or the preparation or
filing of any document or report required to be filed with the Commission.
[FN47] The Commission emphasized its belief that this Rule would "encourage
careful and accurate *9 communications between auditors and the corporations
from whom they request information" and that it was "intended to help restore
the efficacy of the system of corporate accountability and to encourage boards
of directors to exercise their authority to deal with the problem." [FN48]

2. Employee Benefit Plans
An important aspect of a director's duties with respect to corporate
assets is his fiduciary duty to beneficiaries under employee benefit plans
sponsored by the corporation. Directors' responsibilities in this area are
governed by federal law, namely the Employee Retirement Income Securities Act
of 1974 (ERISA). [FN49] Section 404(a)(1)(B) of ERISA requires a fiduciary to
discharge his or her duties "with the care, skill, prudence, and diligence
under the circumstances then prevailing that a prudent man acting in a like
capacity and familiar with such matters would use in the conduct of an
enterprise of a like character and with like aims." [FN50] Overlapping the
"prudent man" standard are two others: "a fiduciary shall discharge his duties
with respect to a plan solely in the interest of the participants and
beneficiaries" of the plan, and he must do this "for the exclusive purpose" of
providing benefits to them. [FN51]
Fiduciaries may not knowingly cause plans which they administer to enter into
any of a number of prohibited transactions, including, with certain exceptions,
the sale, exchange or leasing of property between the plan and a "party in
interest" as defined (which term includes fiduciaries); the lending of money or
other exchange of credit between the plan and a party in interest; [FN52] and
acquisition of securities or real property from the corporate employer in
excess of certain specifically permitted limits. [FN53] Fiduciaries are also
prohibited from dealing in plan assets for their own interest, acting in any
transaction involving the plan on behalf of a party whose interests are adverse
to those of the plan or its participants, or receiving any personal
consideration from any party dealing with the plan in connection with a
transaction involving the assets of the plan. [FN54]
ERISA provides that any person breaching his or her fiduciary duties
thereunder will be personally liable to make good any losses a plan incurs as a
result of the breach. [FN55] A fiduciary will also be liable for a breach of
fiduciary duty by another fiduciary with respect to the same plan under
circumstances including knowing participation in or knowing concealment of acts
or omissions by other fiduciaries which are known to be a breach of duty.
[FN56] If a fiduciary has knowledge of a breach of duty *10 by another
fiduciary, he must make reasonable efforts to remedy the breach. [FN57] There
are criminal penalties for willful violation. [FN58] While ERISA does not
permit exculpatory agreements to relieve a fiduciary of the personal liability
decreed by the statute, an employer may purchase insurance to cover the
potential liability of persons who act in a fiduciary capacity. [FN59]

II. FEDERAL SECURITIES LAWS

The Securities Act of 1933 ("1933 Act") [FN60] and the Securities Exchange
Act of 1934 ("1934 Act") [FN61] impose specific disclosure obligations on
corporate directors and "controlling persons." Compliance with these two
federal regulatory statutes, as well as with other statutes administered by the
SEC, is essential in order to avoid penalties provided thereunder. Violation of
federal securities laws may result in imposition of criminal penalties or civil
injunctions against the corporation, with similar penalties, possibly including
jail sentences, for its directors, officers and employees. [FN62] Substantial
damages may also be imposed. [FN63] Under both the 1933 Act and the 1934 Act,
persons who control a corporation will be liable jointly and severally to the
same extent as the corporation. [FN64] The controlling person may avoid
liability under the 1933 Act by proving lack of awareness of the facts giving
rise to the corporation's liability, [FN65] and under the 1934 Act by proving
good faith and lack of inducement of the conduct in question. [FN66]

A. 1933 Act Registration Requirements
Under the 1933 Act, disclosure is accomplished by requiring
registration every time a corporation sells its securities. [FN67] Unless an
exemption from the Act exists, the registration process must be followed.
[FN68] Significantly, the person asserting an exemption has the burden of
proving his/her rights to rely on it. [FN69]
The 1933 Act imposes liability for participation in an illegal distribution
of securities. [FN70] If a corporation distributes securities through a
registration statement which contains untrue statements or fails to make
necessary statements, the directors of the corporation will be subject to suit
by *11 those persons who purchased the securities. [FN71] Section 11 of the
1933 Act imposes liability upon directors who fail to demonstrate that they
made a reasonable investigation (consistent with the individual's role and
training) of the facts set forth in the registration statement. [FN72] To this
end, directors should have an opportunity to question management, the outside
auditors and legal counsel as to the procedures followed to achieve adequate
and accurate disclosure.
Section 12(2) of the 1933 Act imposes liability upon any person who
negligently sells a security by means of a written offer to sell or an oral
communication which includes an untrue statement or a half-truth. [FN73] Under
expanded definitions of the phrase "person who sells," a director could be
included in the category of seller. [FN74] As a result, a director who
participates in the sale of his corporation's securities may be subject to
liability for negligence in failing to assure that statements in selling
documents are accurate.
Likewise, if a director participates with an issuer in an unregistered
distribution of securities, he may, under the expanded definitions of the
phrase "person who sells," be subject to liability for violation of section
12(1) of the 1933 Act, which grants remedies against a person who unlawfully
offers or sells a security without registration. [FN75]
All of the federal securities law restrictions which apply to the
corporation's dealings with others and to its compliance with the federal
securities laws generally also apply indirectly to those persons within the
corporation who assist the corporation in its activities. These persons may
violate the federal securities laws as participants, as controlling persons, or
as aiders and abettors. [FN76]
Although regulation of the initial distribution of securities is the primary
thrust of the 1933 Act, it is important to recognize that disclosures are also
required when a corporation or a controlling person undertakes to resell
securities previously acquired. [FN77] In such circumstances, the registration
requirements apply to all shares sold by a corporation or by its controlling
persons, and the shares must either be registered or an exemption from
registration must be found. Significantly, a corporate director may, in certain
circumstances, be regarded as a controlling person for this purpose.

*12 B. Continuing Disclosure Requirements
The 1934 Act requires most publicly-owned corporations to file periodic
reports with the SEC and to comply with the federal proxy rules. [FN78] These
include the filing of annual and quarterly reports (Forms 10-K and 10-Q,
respectively) and reports upon the occurrence of specified events (Form 8-K);
disclosure in connection with proxy statements and annual reports to
shareholders; and the filing of reports in connection with tender offers and
takeover bids. [FN79] In addition to the formal disclosure requirements, the
corporation has an ongoing duty to disclose to shareholders and investors,
normally through press releases, all material events in a timely manner. [FN80]
In this connection, the SEC has expressed the view that a corporation violates
the 1934 Act if it makes a positive press release but fails concurrently to
reveal material adverse information (whether or not related to the disclosures
made) about itself. [FN81] The corporation may also be required to make certain
disclosures when it purchases, or offers to purchase, significant amounts of
its own securities or the securities of another corporation. Further, federal
securities laws, as well as a number of state corporations laws, may impose
various other constraints. [FN82]
If a false or misleading statement in a periodic report or other document
filed with the SEC affects the market price of a security, Section 18 of the
1934 Act makes any person who made or caused the statement to be made liable
for damages to anyone who purchases or sells the security in reliance on the
statement, unless the person sued proves that he "acted in good faith and had
no knowledge that such statement was false or misleading." [FN83] Section 18
applies only to periodic SEC reports and to proxy statements. [FN84] In part
because of the necessity for an investor to prove reliance upon a document
filed with the Commission, instances of liability under Section 18 are rare.
More frequently, claims based on false and misleading statements in reports
and other communications have been brought under the broader antifraud
provisions of the 1934 Act. [FN85] Rule 10b-5 states that it is unlawful for
any person in connection with the purchase or sale of a security:
to make any untrue statement of a material fact or omit to state a material
fact necessary in order to make the statements made, in the *13 light of
the circumstances under which they are made, not misleading .... [FN86]
The antifraud provisions are not limited in their application to documents
filed with the Commission. For example, the provisions cover statements in
shareholder reports and press releases. [FN87]
Although proxy statements are subject to the provisions of the 1934 Act that
apply to false and misleading statements in filed documents [FN88] and to the
antifraud provisions that may apply to any communication, [FN89] proxy
statements are governed by separate provisions of the 1934 Act which have been
interpreted to impose a higher standard of care than is applicable in some
other contexts. [FN90]
Rule 14a-9 under the 1934 Act provides that no solicitation shall be
made by means of any proxy statement or other communication which shall contain
a statement that,
at the time and in the light of the circumstances under which it is made,
is false or misleading with respect to any material fact, or which omits to
state any material fact necessary in order to make the statements therein not
false or misleading .... [FN91]
Guidance as to what constitutes a material fact in a proxy statement has been
given by the Supreme Court in TSC Industries, Inc. v. Northway, Inc. [FN92] The
general standard of materiality as set forth in that case is that "[a]n omitted
fact is material if there is a substantial likelihood that a reasonable
shareholder would consider it important in deciding how to vote." [FN93]
As a result of these provisions, it is extremely important for directors to
ascertain that all reasonable efforts are made to assure that corporate
publicity and reports are accurate and complete. Further, it is important that
public disclosure of material developments be made on a timely basis when the
information is reliable and appropriately verified, subject in certain limited
cases to legitimate deferral in furtherance of a valid corporate purpose. To
this end, directors should examine the procedures established for corporate
publicity and reports, including the role of legal counsel and, in the case of
financial information, the corporation's auditors, and should also consider the
role and involvement of the directors and senior management in the process.
Circumstances vary widely, and there can be no broadly prescribed procedures.
While they should not be held responsible for personally verifying the accuracy
of underlying *14 facts contained in corporate publicity and reports, the
directors should be satisfied that the procedures in place are reasonably
designed to assure that accuracy and completeness will be achieved.

C. The Williams Act
The so-called Williams Act [FN94] provisions of the 1934 Act require persons
making tender offers or owning beneficially more than 5% of the outstanding
stock of a corporation to file certain disclosure documents (on Form 13D) and
to comply with other substantive requirements. [FN95]
The determination of the beneficial ownership of securities in cases of
complex corporate structures may sometimes be difficult. Section 13(d)(1)
imposes disclosure requirements on a person who "directly or indirectly"
acquires the "beneficial ownership" of more than 5% of a class of publicly
traded equity securities. [FN96] Securities Exchange Act Rule 13d-3 states:
a beneficial owner of a security includes any person who, directly or
indirectly, through any contract, arrangement, understanding, relationship,
or otherwise has or shares:
(1) Voting power which includes the power to vote, or to direct the voting
of, such security; and/or,
(2) Investment power which includes the power to dispose, or to direct the
disposition of, such security. [FN97]
Failure to file under Section 13(d) and (e) exposes the company and its
directors to the possibility of an enforcement action by the SEC and to legal
actions by the company's shareholders. [FN98]

D. Insider Trading
The federal securities law also prohibits corporate insiders from purchasing
or selling securities, either in the open market or in private transactions,
without revealing all material information known to them about their
corporation. [FN99] The federal courts have stated clearly that insiders,
including directors, who do not make adequate disclosures must refrain from
entering into securities transactions. [FN100]
Not only do the federal securities laws prohibit insiders from taking
advantage of material nonpublic corporate information, but they prohibit them
from giving tips-either by revealing nonpublic information to others *15 for
the purpose of assisting their trading activities or by making recommendations
to buy or sell based upon such information. [FN101] The federal securities laws
also prohibit the receiver of tips, the "tippee," from acting on corporate
inside information. [FN102]
The prohibitions against trading based upon inside information raise concerns
regarding directors' possible possession of material inside information. The
corporation's management can be helpful in providing directors with guidance as
to whether at any given time there is any material information concerning the
corporation which is not public. Many corporations have developed procedures
for directors to contact regular corporate counsel before trading, permitting
each proposed transaction to be reviewed by counsel in the light of the current
state of public information.
Section 16(a) of the Exchange Act requires beneficial owners of more than 10%
of a class of publicly traded equity securities, as well as officers and
directors of corporations that issue such securities, to file reports with the
SEC disclosing the amount of all classes of the issuer's securities that are so
beneficially owned. [FN103] Initial reports of beneficial ownership must be
made on Form 3 within ten days after any person becomes the beneficial owner of
10% or more of any class of equity security or becomes an officer or director.
[FN104] Statements of changes in ownership must be filed on Form 4 within ten
days after the end of each month in which any change in beneficial ownership
has occurred. [FN105]
Section 16(b) of the Exchange Act allows the issuer, or any security holder
suing on its behalf, to recover certain securities trading profits made by a
stockholder owning more than 10% of any class of its equity securities, or by
any of its officers or directors. [FN106] The profits recoverable from the
above-described persons are those arising from any purchase and sale, or any
sale and purchase, of any equity security of the company within a period of
less than six months. [FN107] To be liable, a beneficial owner must own at
least 10% of the stock at the time of both the purchase and the sale of the
security involved. [FN108]
Liability may unexpectedly result from the application of section
16(b), since the profit realized is determined by considering all of the
individual's transactions within a six month period and matching them by taking
the highest sale price and the lowest purchase price until all purchases and
sales have been accounted for. [FN109] Under this system, the highest sales
price during a six month period is matched with the lowest purchase price
during that period and each purchase and sale or sale and purchase *16 is
then compared in order to compute "profit" in a manner so as to produce the
greatest possible profit. [FN110] As a result, it is possible for a beneficial
owner or director to be liable to make payment to his corporation under section
16(b) even though he has not in fact made a profit.

1. Definition of Purchase or Sale
Section 16(b) has been broadly interpreted so that the terms "purchase" and
"sale" may in certain circumstances include gifts, reclassifications,
intercorporate transactions and pledges. [FN111] Thus, a merger of the
corporation with another corporation could be a sale or purchase transaction
and could be matched with purchases and sales made six months before or after
the merger.

2. Timing of Purchase
An individual may be subject to liability as a director for purchases or
sales which occurred before becoming a director or after his status as a
director terminates. [FN112] Thus, if a director purchases (sells) shares of
his corporation, resigns, and sells (purchases) those shares within six months
after the purchase (sale), liability will be imposed for short swing profits.
Although Section 16(a) and Section 16(b) are based on beneficial ownership of
securities, as is Section 13(d), the concepts of beneficial ownership under
Section 13(d)(1) and Section 16 may be different. In an interpretive release,
the SEC has stated:
The Commission has never specifically defined the term "beneficial
ownership" for purposes of Section 16(a) of the Exchange Act .... Rule 13d-3
[17 CFR 240.13d-3] under the Exchange Act sets out a very detailed
definition of beneficial ownership for purposes of the reporting requirements
under Section 13(d) and the Commission's tender offer rules. While the
concepts of beneficial ownership under Section 16(a) and under Rule 13d-3
have much in common, the former stresses the economic benefit to be derived
from the securities and the latter emphasizes the ability to control or
influence the voting or disposition of the securities. As a result, different
determinations of beneficial ownership under the section and rule are
possible. [FN113]
*17 Whether an individual or corporate entity has the ability to "control
or influence the voting or disposition of the securities" of a publicly-held
U.S. company is a factual question which can only be answered after full
discussion of all the pertinent facts with legal counsel.

III. GUIDELINES FOR PERFORMANCE OF DUTIES

The responsibilities of the individual corporate director have been
outlined above. This section translates those responsibilities into more
specific actions which directors might take in order to meet their legal
responsibilities.

A. Corporate Management
As discussed above, the fundamental responsibility of the individual
corporate director is to represent the interests of the shareholders as a
group, as the owners of the enterprise, in directing the business and affairs
of the corporation within the law. To this end directors should:

- review and confirm basic corporate objectives

- select competent senior executives and monitor personnel policies and
procedures with a view to assuring that the enterprise is provided with
other competent managers in the future

- review the performance of the senior managers thus selected and monitor the
performance of the enterprise.
Under the Model Business Corporation Act, the individual corporate director,
together with his fellow directors, is also required or authorized to:

- adopt or change bylaws

- approve amendments to the articles of incorporation (subject to shareholder
approval)

- cancel reacquired shares

- allocate to capital surplus consideration received for shares without par
value

- change the registered office or registered agent

- approve any plan of merger or consolidation (subject to shareholder
approval)

- recommend dissolution

- declare dividends

- elect corporate officers

- call special meetings of the shareholders [FN114]
In addition, each corporate director should be concerned that appropriate board
attention is given to material transactions affecting the assets of the
enterprise, such as those involving the issuance or reacquisition of *18 its
securities or indebtedness, capital investment, business acquisitions or
dispositions or other new business activities.
The corporate director should be concerned that the enterprise's principal
disclosure documents, such as prospectuses, proxy statements and annual reports
to shareholders, are complete and accurate. While the individual should read
such documents carefully for possible errors or omissions of which he may have
personal knowledge, his primary responsibility is to be satisfied that
procedures being followed are likely to result in completeness and accuracy in
the preparation of these disclosure documents, including the opportunity for
their review by the corporation's auditors and legal counsel. Questions that
the individual director may have regarding the adequacy of disclosure should be
pursued by him until satisfactorily resolved, and he should familiarize (and
satisfy) himself concerning the procedures established for authorization,
review and clearance of both disclosure documents and important press releases.
In exercising his duties, it is important that the corporate director avoid
taking an adversarial attitude in his relationship with management. However, in
those special cases where actual or potential conflicts of interest involving
management or those advising management are presented, it has been
appropriately suggested that "[a] healthy skepticism and a bias toward seeking
outside advice are useful attitudes for the outside director ...." [FN115]
If a corporate director has reservations concerning a proposed course
of action, he has a duty to express them to both management and his fellow
directors. If he disagrees with any action taken by the board having
significant implications or consequences, he should vote against the proposal
and request that his dissent, and reasons therefor, be recorded in the minutes
of the meeting. [FN116] Genuine disagreement regarding a particular proposal
normally should not cause him to consider resigning.

B. Information Flow
The corporate director should be concerned with the establishment and
maintenance of an effective reporting system. The information flow from
management to members of the board should encompass:

- internal financial statements, structured in a way that presents a
meaningful breakdown of the enterprise's activities and summarized in a way
that permits ready comprehension and reasonable analysis

- periodic briefing by senior executives concerning developments affecting
the business and affairs of the enterprise; in some cases, this dimension
of reporting will be effectively accomplished by a memorandum from the
chief executive officer distributed to the board members in advance of each
meeting

*19 - forward planning, including crucial issues facing the enterprise and
new directions appropriate for board consideration in the context of
corporate policy.
Aside from direct communications from the chief executive officer and the chief
financial officer, the corporate secretary frequently serves as the regular
channel of communication to directors on corporate matters. The adequacy of the
information provided to directors should be reviewed from time to time.
The corporate director should also obtain, to the extent available,
information materials available from outside sources, such as research analyses
by investment firms and business publication materials, dealing with not only
the enterprise but also with its competitors and trade association advisory
reports.
The corporate director should feel that he is sufficiently informed about a
proposal so that he can explain a vote for or against it. If he believes that
adequate information is not being provided for such purposes and is
unsuccessful in his efforts to remedy the situation, he should consider
resigning.

C. Legal Compliance and Assistance
The corporate director should be concerned that the corporation has programs
looking toward compliance with applicable laws and regulations, both foreign
and domestic; that it circulates (as appropriate) policy statements to this
effect to its employees; and that it maintains procedures for monitoring such
compliance. In order to facilitate the corporation's compliance with the law,
it is desirable that regular corporate counsel have appropriate access to the
board of directors; that the corporation be supplied with legal services
adequate to assure that its policies will be implemented; and that all lawyers
rendering legal services for the corporation have a direct channel of
communication to regular corporate counsel so as to assure that failures of
compliance will be promptly brought to his attention and, in appropriate cases,
by regular corporate counsel to the chief executive officer, in order to permit
corrective steps to be taken. Not only will adequate legal services contribute
to the implementation of a corporation's legal compliance policies, but it is
more likely that a corporation's public disclosure obligations in regard to
legal problems will be appropriately discharged.
Directors should ask to be advised concerning any special legal
compliance problems, such as court orders imposing continuing restrictions on
operations or higher standards of conduct in particular areas. Examples would
include an antitrust consent decree restricting the corporation's marketing
practices for certain products or prohibiting acquisitions in certain markets,
or a consent decree directed toward future compliance with disclosure
responsibilities under the federal securities laws. The director's inquiry
should be as to the existence of mechanisms that will cause the corporation to
observe such special legal requirements.
There may be occasions when there is need for the corporate director to have
outside advice. The director should be assured that, in appropriate
*20 circumstances, he (alone or together with fellow directors) has a direct
channel of communication with the enterprise's principal advisors, including
its auditors, its regular corporate counsel and, when such a relationship
exists, its investment banking advisors and its executive compensation
counselors. Further, there may be occasions when an outside advisor should be
specially retained to assist the board or a committee in connection with a
particular matter. The need for outside advice should be infrequent, arising
most often in the unusual or corporate crisis situation.

D. Disclosure and Confidentiality
The discussion of federal securities laws above deals principally with SEC
requirements for filing disclosure documents. Additionally, if a material event
occurs, it should be reported promptly to investors generally, although courts
have recognized that a variety of proper business purposes will justify a delay
in disclosure. [FN117] Typically, such public disclosure is accomplished
through a press release. Occasionally the releases are mailed directly to
shareholders, in addition to distribution through other financial information
channels. Certain developments are appropriate for public disclosure, but may
not be so critical as to make an immediate press release appropriate. These
items can be communicated as part of the quarterly earnings reports.
Press releases must avoid misstatements or material omissions. A high degree
of accuracy, completeness and balance between positive and negative factors is
required. There is no room for the degree of puffing in financial disclosures
which would be acceptable in general commercial advertising or other areas of
commercial communication.
In this connection directors should make sure that the corporation adopts
internal procedures regarding disclosures to the financial community. The
corporation should be certain that material information is disclosed on a
timely basis when appropriate, and also that there are no leaks or inadvertent
disclosures when release of information is inappropriate. There should be clear
lines of authority and responsibility within the corporation, with a limited
number of persons authorized to deal with the financial community. All
employees should be alerted to these basic principles, including particularly
the obligations to maintain the confidentiality of undisclosed material
information and to refrain from trading while privy to such information.
As a corollary of the foregoing, it is essential that the
confidentiality of material information be strictly maintained by all persons
who may have access to that information, regardless of title or position. A
public company normally has some degree of discretion in determining when
*21 an event is ripe for public disclosure, assuming no leaks. A reasonable
standard, consistently applied for affirmative as well as negative information,
usually will avoid difficulties. However, there are certain circumstances where
a company's hand may be forced and good practices will require a disclosure-for
example, where there has been a leak of information or where rumors are
circulating in the financial community. Care should be taken to prevent these
circumstances.

E. Director's Role in Selected Circumstances

1. Financial Audits
The proper conduct of the financial audit bears directly upon directors'
personal exposure to liability as well as upon the financial welfare of the
corporation and its shareholders. Audited financial statements lie at the heart
of the annual report to shareholders required of all publicly-held business
corporations, as well as of annual reports and registration statements filed
with the SEC. [FN118] As discussed above, a person will be exposed to legal
liability under the federal securities laws if he or she shall "make or cause
to be made" any statement that is "false or misleading with respect to a
material fact" in a report filed under the 1934 Act. [FN119] As for audited
financial statements in 1933 Act registration statements, directors probably
would be among those called upon to defend themselves in the event of a claim
that the financial statements were false or misleading. The directors would
then bear the burden of proving that they "had no reasonable ground to believe
and did not believe" that the financial statements were false or misleading.
[FN120]
The independence of the auditor is central to the function of the financial
audit. The auditor's independence in fact, in the sense of freedom from
management influence, is in turn a matter about which the board of directors
needs to be assured. To perform this task, the board of directors often forms
an audit committee. [FN121]
A principal function of the independent audit committee is to protect the
auditors from undue management influence by serving as a communications link
between the independent auditors (as well as the corporation's internal audit
staff) and the board of directors. [FN122] In the SEC's view the review of an
audit by the audit committee should cover the following in addition to the
auditor's report or opinion:

- the auditor's perception of the corporation's financial and accounting
personnel;

*22 - the cooperation they received during the audit;

- the extent to which the corporation's resources were and should be used to
minimize the time spent;

- any significant transactions not a normal part of the corporation's
business;

- any changes in accounting principles and practices;

- any significant proposed adjustments; and

- any recommendations the auditors may have for improving internal accounting
controls, choice of accounting principles, or management systems. [FN123]
In practice the audit committee's review should include review, before
publication, of the financial statements themselves.

2. Acquisitions and Mergers
Three fundamental questions arise in merger transactions: (1) should
management have the exclusive role in framing the merger; (2) to what extent
can the director rely upon the management's presentation of the facts of the
merger proposal; and (3) can a director conscientiously vote for the
transaction if he or she thinks the proposal is merely within reason, as
opposed to one that coincides precisely with the director's personal view of
the transaction. Professors Leech and Mundheim, who pose these questions in
assessing the outside directors' role in mergers, suggest that the answer to
each depends upon the degree to which the directors have reason to believe that
management's interests may diverge from those of the shareholders. [FN124]
Directors seeking to satisfy themselves as to the desirability of a merger
will want to direct their attention to the following matters:

- Does the merger make substantive, long-term good sense for the company?

- Are there special factors (such as those referred to in the preceding
paragraph) that may cause management's judgment to be skewed in the
particular case?

- How successful have been management's prior experiences in evaluating and
acquiring companies and in securing the expected benefits of such
acquisitions?

- Is there a determination, based on articulated standards, of the cash worth
of the company being acquired (including a justification for any premium
over market value)? [FN125]
The director's fiduciary duties to the corporation include the duty to act
honestly and fairly when acquisition proposals are made to the
*23 corporation or its shareholders. [FN126] Directors presented with
acquisition proposals have the duty to exercise independent judgment in
evaluating the proposal and in making a recommendation to shareholders. The
question of performing or breaching these fiduciary duties is presented, along
with other legal issues, whenever the board of directors authorizes the use of
corporate funds to conduct a proxy contest or to defend against a tender offer.
The issue involved is easily stated: whether the expenditures were made and
other actions were taken in the interest of furthering some legitimate
corporate purpose, or were intended solely or primarily to enable management to
perpetuate itself in office. [FN127]

3. Management Compensation
The legal issue involved in management compensation is basically the fairness
of the compensation. Generally, the directors have the exclusive right to
determine the value of services rendered by the executive officers, and the
directors' decision as to the amount is final if made as result of a good faith
exercise of honest business judgment. Under familiar principles, a decision
based upon the directors' self-interest or involving some breach of trust would
not be protected. The protection of the business judgment rule may also be
dissolved when the amount of compensation (in the form of salaries or bonuses
or both) is so large as to amount to a waste of corporate assets. [FN128] Novel
arrangements such as severance payments linked to changes in control of the
employer corporation in some cases involve very large amounts; legal challenges
which are just beginning to move through the courts may result in developments
in the law governing management compensation.
Guidelines to assure that directors' decisions relating to management
compensation are soundly based, and demonstrably so, are as follows:

- create compensation plans that work on the basis of relevant business
factors and are consistent with the long-term interests of the
corporation - e.g., compensation practices that do not encourage
maximization of short-term profit at the expense of longer-term growth;

- review any variable compensation plan continually to see that it operates
fairly and objectively;

- periodically scrutinize any bonus plan as to philosophy and application -
e.g., make an effort to confine it to management personnel whose effect on
the corporation is measurable and upon whose performance the incentive is
measurable;

*24 - take steps to reform any compensation plan that begins to yield
amounts not reasonably related to executive performance;

- have financial calculations under incentive compensation plans reviewed by
independent accountants;

- obtain advice from independent counsel when questions arise concerning
compensation arrangements as to which inside counsel has a personal
interest. [FN129]

CONCLUSION

This article is a general summary and outline of some very complex legal
principles and requirements. It necessarily omits details, refinements and
exceptions which would be pertinent in the legal analysis of a particular issue
and therefore should not be used in the place of legal advice in taking
specific actions.

FNa1. Member of the firm of Davis, Polk & Wardwell, New York City. Mr. Gil
would like to acknowledge the contributions of his associates, Michael Willisch
and Joseph Cohn to this article.

FN1. A "controlling person" for the purposes of this article is a person or
corporate entity which has the ability to control or influence the voting or
disposition of 10% or more of the securities of a U.S. publicly-owned company,
whether through direct or indirect ownership of such securities, by corporate
agreements or otherwise.

FN2. See MODEL BUSINESS CORP. ACT ANN. s 8.30 (3d ed. 1994) [hereinafter MODEL
ACT]. The "business judgment rule" immunizes management from liability in
corporate matters when there is a reasonable basis to indicate that the
transaction was made with due care and in good faith. BLACK'S LAW DICTIONARY
200 (6th ed. 1990).

FN3. See MODEL ACT s 8.51.

FN4. See id. s 8.60 for definitions relating to conflicts of interest.

FN5. See id. s 8.24 for quorum and voting requirements.

FN6. While Delaware, New York and California allow an interested director to be
counted toward a quorum of the board of directors, see DEL. CODE ANN. tit. 8, s
144(b) (Repl. Vol. 1983)); N.Y. BUS. CORP. s 713(c) (McKinney 1986); CAL.
CORP. s 310(c) (1977), other states such as Alabama and Minnesota do not. See
ALA. CODE s 10-2A-63 (Repl. Vol. 1980); MINN. STAT. s 302A.255(1)(c) (1985).

FN7. MODEL ACT, supra note 2, s 8.31(c), (d).

FN8. See, e.g., DEL. CODE ANN. tit. 8, s 144(a) (Repl. Vol. 1983) (finding no
transaction voidable solely for reason of conflict of interest if the
transaction is fair to the corporation).

FN9. Courts have also looked at whether the transaction was fair and
reasonable. See In re Franklin Nat'l Bank Sec. Litig. v. Franklin Nat'l Bank,
2 B.R. 687, 707 (E.L.N.Y. 1979), aff'd, 633 F.2d 203 (2d Cir. 1980).

FN10. See Miller v. Miller, 222 N.W.2d 71, 78 (Minn. 1974) (acknowledging
that directors cannot exploit their positions as insiders by appropriating
business opportunities properly belonging to the corporation).

FN11. See generally MODEL ACT, supra note 2, ss 8.60-8.63, cmt. at 8-391.

FN12. Trading in confidential inside information obtained by virtue of an
inside position is prohibited by Securities and Exchange Commission rule 10b-5.
See SEC v. Texas Gulf Sulphur Co., 401 F.2d 833 (2d Cir. 1968), cert.
denied, 394 U.S. 976 (1969).

FN13. The corporation may become competitively disadvantaged; for example, if
one of its directors disclosed new product developments and that information
facilitated a competitor's introduction of a similar product.

FN14. MODEL ACT, supra note 2, s 8.30(a).

FN15. Id. s 8.30(b).

FN16. See supra note 2.

FN17. As of December 1, 1993, thirty-eight jurisdictions require that a
director discharge his duties in good faith and with a stated standard of care.
MODEL ACT, supra note 2, s 8.30, cmt. at 8-175 to 8-176.

FN18. Instead, "director liability is predicated upon concepts of gross
negligence." Smith v. Van Gorkom, 488 A.2d 858, 873 (Del. 1985) (quoting
Aronson v. Lewis, 473 A.2d 805, 812 (Del. 1984)).

FN19. Paramount Communications, Inc. v. QVC Network, Inc., 637 A.2d 34 (Del.
1994) (finding court will not substitute its views for those of directors).

FN20. See Aronson, 473 A.2d at 812.

FN21. See id.

FN22. MODEL ACT, supra note 2, s 8.51.

FN23. See, e.g., Blasband v. Rales, 971 F.2d 1034 (3d Cir. 1992).

FN24. See, e.g., Pestolite, Inc. v. Cordura Corp., 449 A.2d 263 (Del. Super.
Ct. 1982).

FN25. MODEL ACT, supra note 2, ss 8.50(4)-(5), 8.51(d).

FN26. Id. s 8.51(a)(1)(i), (ii)(A)(B).

FN27. Id. s 8.51(a)(1)(iii).

FN28. Id. s 8.52.

FN29. Id. s 8.55.

FN30. 15 U.S.C. ss 77a-77aa (1988) [hereinafter 1933 Act].

FN31. See, e.g., Globus v. Law Research Serv., Inc., 418 F.2d 1276 (2d Cir.
1969), cert. denied, 397 U.S. 913 (1970) (finding that the policies
underlying the 1933 Securities Act render void an indemnification agreement to
the extent that as applied it would cover fraudulent misconduct).

FN32. MODEL ACT, supra note 2, s 8.01(b).

FN33. See, e.g., DEL. CODE ANN. tit. 8, s 141 (Repl. Vol. 1983); N.Y. BUS.
CORP. s 701 (McKinney 1986).

FN34. 15 U.S.C. ss 78dd-1 to -2, s 78ff (1988).

FN35. See infra text accompanying notes 46-47.

FN36. Combined public and private pension assets total roughly $4.4 trillion.
Joel Chernoff, U.S. Pension Assets Reach $4.4 Trillion, in PENSIONS &
INVESTMENTS 1 (Jan. 25, 1993).

FN37. 15 U.S.C. ss 78a-78kk (1988) [hereinafter 1934 Act].

FN38. See supra note 34.

FN39. 15 U.S.C. s 78dd-1(a) (1988).

FN40. 15 U.S.C. s 78m(b)(2)(A) (1988).

FN41. 15 U.S.C. s 78m(b)(2)(B) (1988).

FN42. See H.R. REP. No. 640, 95th Cong., 1st Sess. 8 (1977).

FN43. Promotion of the Reliability of Financial Information and Prevention of
the Concealment of Questionable or Illegal Corporate Payments and Practices,
Exchange Act Release No. 34-15570, 1979 WL 17892, at *1 (SEC) (Feb. 15,
1979) [hereinafter Exchange Act].

FN44. 17 C.F.R. s 240.13b2-1 (1994).

FN45. Exchange Act, supra note 43, at *1.

FN46. 17 C.F.R. s 13b2-2(a) (1994).

FN47. Id. s 13b2-2(b).

FN48. Exchange Act, supra note 43, at *11.

FN49. 29 U.S.C. ss 1001-1461 (1988 & Supp. IV 1992).

FN50. Id. s 1104(a)(1)(B).

FN51. Id. ss 1104(a)(1), (a)(1)(A)(i). A fiduciary shall also discharge his
duties for the purpose of "defraying reasonable expenses of administering the
plan." Id. s 1104(a)(1)(A(ii).

FN52. Id. s 1106(a)(1)(B).

FN53. Id. s 1107(a).

FN54. Id. s 1106(b).

FN55. Id. s 1109(a).

FN56. Id. s 1105(a)(1).

FN57. Id. s 1105(a)(3).

FN58. Id. s 1131.

FN59. Id. s 1110.

FN60. 15 U.S.C. ss 77a-77aa (1988).

FN61. Id. ss 78a-7811.

FN62. See, e.g., id. s 78ff (criminal penalties under 1934 Act).

FN63. Id.

FN64. See, e.g., id. s 78t (discussing liability of controlling persons under
1934 Act).

FN65. Id. s 77o.

FN66. Id. s 78t.

FN67. Id. s 77e(c).

FN68. Id. s 77d.

FN69. See, e.g., SEC v. Murphy, 626 F.2d 633, 641 (9th Cir. 1980).

FN70. 15 U.S.C. s 771 (1988).

FN71. Id. s 77k(a).

FN72. Id.

FN73. Id. s 771.

FN74. See, e.g., Jubran v. Musikahn Corp., 673 F. Supp. 108, 113 (E.D.N.Y.
1987).

FN75. 15 U.S.C. s 77k(a) (1988).

FN76. See, e.g., id. (liability under section 11 of the 1933 Act attaches to
directors); id. s 78t (controlling persons jointly and severally liable for
violations of either section 11 or section 12 of the 1934 Act); THOMAS L.
HAZEN, THE LAW OF SECURITIES REGULATION s 7.2, at 281 (2d ed. 1990) (finding
that aiding and abetting liability generally applies to the securities acts).

FN77. These disclosures may be required because the controlling person fits
within section 2(11)'s broad definition of under writing, which includes
persons who acquire securities with a view toward distribution. 15 U.S.C. s
77b(11) (1988).

FN78. Id. ss 78q, 78n.

FN79. See 17 C.F.R. ss 240.13a-1 (annual reports); 240.13a-13 (quarterly
reports); 240.13a-11 (special events); 240.14a-3 to -12 (proxy solicitations);
240.14d-1 to -103 (tender offers and takeover bids).

FN80. Timely Disclosure of Material Corporate Developments, Exchange Act
Release No. 33-5092, Release No. 34-8995, Release No. IC-6209, 1970 WL 5619,
at *1 (SEC) (Oct. 28, 1970) [hereinafter Timely Disclosure].

FN81. Id.

FN82. For example, section 13(d) of the 1934 Act requires any person who
acquires more than five percent beneficial ownership interest in any class of
equity securities subject to the Act's reporting requirements to file a
statement of ownership with the SEC. 15 U.S.C. s 78m(d) (1988).

FN83. Id. s 78r(a).

FN84. See id.

FN85. The primary antifraud provision contained in the 1934 Act is Rule 10b-5.
17 C.F.R. s 240.10b-5 (1992).

FN86. 15 U.S.C. s 78n(e) (1988).

FN87. Timely Disclosure, supra note 80.

FN88. Section 18(a) of the 1934 Act imposes liability on any person responsible
for false or misleading statements in connection with documents required to be
filed with the SEC. 15 U.S.C. s 78r(a) (1988).

FN89. 17 C.F.R. s 240.10b-5 (1992).

FN90. 15 U.S.C. s 78n (1988).

FN91. 17 C.F.R. s 240.14a-9(a) (1992).

FN92. 426 U.S. 438 (1976).

FN93. Id. at 449.

FN94. Pub. L. No. 90-439, 82 Stat. 454 (1968) (codified at 15 U.S.C. ss
78m(d), 78n(d)-(f)).

FN95. 17 C.F.R. s 240.13d-1 (1992).

FN96. Id.

FN97. 17 C.F.R. s 240.13d-3 (1992).

FN98. The SEC has been given wide investigatory and enforcement powers in the
courts. See generally Thomas L. Hazen, Administrative Enforcement: An
Evaluation of the Securities and Exchange Commissions' Use of Enforcement
Techniques, 31 HASTINGS L.J. 427 (1979).

FN99. 15 U.S.C. s 78t (1988).

FN100. See Affiliated Ute Citizens v. United States, 406 U.S. 128, reh'g
denied, 407 U.S. 916 (1972) (finding that rule 10b-5 bars insiders from
engaging in purchases or sales of securities while in possession of material
nonpublic information without making adequate disclosure).

FN101. 15 U.S.C. s 78t-1 (1988).

FN102. Id. s 78t(b).

FN103. Id. s 78p(a).

FN104. Id.

FN105. See id.

FN106. Id. s 78p(a).

FN107. Id. s 78p(b).

FN108. Id. s 78p(a).

FN109. See Arrow Distrib. Corp. v. Baumgartner, 783 F.2d 1274 (5th Cir.
1986).

FN110. Id.

FN111. For example, although a gift generally is not subject to section 16(b),
if a donee is the alter ego of the corporate insider and sells a security soon
after receiving it as a gift, then the sale of such security may be attributed
to the insider and thus trigger section 16(b) liability. See Truncale v.
Blumberg, 80 F. Supp. 387, 391 (S.D.N.Y. 1948).

FN112. See Feder v. Martin Marietta Corp., 406 F.2d 260 (2d Cir. 1969),
cert. denied, 396 U.S. 1036 (1970) (finding section 16(b) liability attached
to director who resigned prior to a sale at a profit within six months of his
purchase); Adler v. Klawans, 267 F.2d 840 (2d Cir. 1959) (attaching section
16(b) liability to officer who became officer after his purchase but prior to
sale within six months of purchase).

FN113. Interpretive Release on Rules Applicable to Insider Reporting and
Trading, Exchange Act Release No. 18114, 46 Fed. Reg. 48,147 (SEC) (Oct. 1,
1981) (emphasis added).

FN114. See MODEL ACT, supra note 2, ss 2.06 (adopt bylaws); 10.03 (approve
amendments); 6.31 (acquire shares); 6.40(2a-c) (shareholder distribution
rules); 5.02 (change of office or agent); 11.01 (approve merger plan); 14.02
(recommend dissolution); 6.40(1a) (declare dividends); 8.40 (elect officers);
7.02 (call special meetings).

FN115. Noyes E. Leech & Robert H. Mundheim, The Outside Director of the
Publicly Held Corporation, 31 BUS. LAW. 1799, 1823 (1976).

FN116. See MODEL ACT, supra note 2, s 8.24(d).

FN117. Preliminary acquisition negotiations, for example, need not be disclosed
until an agreement has been reached as to the transaction's structure and
price. See Flamm v. Eberstadt, 814 F.2d 1169, 1177 (7th Cir.), cert.
denied, 484 U.S. 853 (1987) (finding preliminary acquisition negotiations
nonmaterial).

FN118. See, e.g., 1934 Act, supra note 37, s 78n(c); 17 C.F.R. s 240.14c-
3(1) (1981); 1933 Act, supra note 30, Schedule A, Items 25, 26.

FN119. 15 U.S.C. s 78r(a) (1988).

FN120. Id. s 77k(b)(3).

FN121. See MODEL ACT, supra note 2, s 8.25(a) (authorizing board of directors
to create committees and appoint members).

FN122. See generally id. s 8.25, cmt. at 8-146 (finding audit committees
perform vital review and control functions).

FN123. Proposed Rules Relating to Shareholder Communications, Shareholder
Participation in the Corporate Electoral Process and Corporate Governance
Generally, Exchange Act Release No. 34-14970, 1978 WL 19391, at *19 n.21
(SEC) (July 18, 1978).

FN124. Leech & Mundheim, supra note 115, at 1816-18.

FN125. Harold M. Williams, Then-SEC Chairman's Address on the Role of the
Bidder's Directors in Takeovers (Mar. 12, 1980) (reported in the Review of
Securities Regulation Vol. 13, No. 5).

FN126. These duties are derived from the director's general duty of care found
in MODEL ACT, supra note 2, s 8.30.

FN127. See EDWARD R. ARANOW ET AL., DEVELOPMENTS IN TENDER OFFERS FOR CORPORATE
CONTROL 269-70 (1977). See also Martin Lipton, Takeover Bids in the Target's
Boardroom: An Update After One Year, 36 BUS. LAW. 1017, 1019-22 (1981).

FN128. See Pogistin v. Rice, 480 A.2d 619, 626 (Del. 1984) (stating that
challenges to compensation plans must allege that compensation was "so devoid
of a legitimate corporate purpose as to be a waste of assets").

FN129. See generally Leech & Mundheim, supra note 115, at 1823.