What is an investment contract? For securities laws purposes?

This case is not in the textbook but is helpful I think.

1.  Name of the Case and case cite. 

Smith v. Gross, 9th Cir Court of Appeals, 1979

2.  Who is the plaintiff or movant?  Who is the defendant or respondent?

            Plaintiff is an investor in an earthworms farm

            Defendant is the promoters/sellers 

3.  Exactly what relief has the plaintiff requested?

            Plaintiff seeks damages for violations of “federal securities laws.”   Note:  that is how the federal court got jurisdiction.  

4.  What is the legal basis for the request?

            They entered into an investment contract with the defendants.  The contract was a security which was not registered or exempt.            

5.   What facts does the plaintiff provide that support the request?

            Plaintiffs bought an “earthworms farm.”  The seller defendant’s told them that “very little work was required” and defendants would buy the worms produced which would “guarantee success.”  They said also that they were mislead by representations about how fast worms multiply each year.     

6.   How did the case end at the trial court level?

            The trial court dismissed the complaint “for lack of subject matter jurisdiction” saying the transaction did not involve federal securities laws.  The Court of Appeals reversed.     

7.  Given how the case ended, what is the standard that the court used to resolve the issue?

               Plaintiff did not state a claim for relief.  It’s not clear how or when the trial court dismissed the case.    

8.   What is the defendant’s opposition? 

            The transaction was not a security therefore could not be brought in federal court.   Sellers were simply selling worms and a business concept.  Plaintiffs ran their own business, made profits based on their own abilities.      

9.   Who won and Why?  What is the court’s reasoning for giving the plaintiff what she requested or denying the request. 

            The plaintiffs won at least sending the case back to federal district court.  The C/A said this was an investment contract because it is 1. an investment of money, 2. in a common enterprise, 3. with profits to come solely from the efforts of others.   A big factor was that the deal plaintiffs made was that they would buy worms and that defendants would buy them back at a guaranteed price which guaranteed a certain profit.  The buyers of the worms were not the public but the defendants.        

Summary of the Duties of the Board of Directors

This is such a great summary of the duties of the board of directors from three attorneys at Sidley Austin LLP – Claire H. HollandHolly J.Gregory and Rebecca Grapsas:

Responsibilities of the board (supervisory)

Board’s legal responsibilities

What are the board’s primary legal responsibilities?

The primary legal responsibility of the board is to direct the business and affairs of the corporation (see DGCL, section 141). While the functions of a board are not specified by statute, it is generally understood, as noted in the ALI’s Principles of Corporate Governance and other codes of best practice, that board functions typically include:

  • selecting, evaluating, fixing the compensation of and, where appropriate, replacing the CEO and other members of senior management;
  • developing, approving and implementing succession plans for the CEO and senior executives;
  • overseeing management to ensure that the corporation’s business is being run properly;
  • reviewing and, where appropriate, approving the corporation’s financial objectives and major corporate plans, strategies and actions;
  • understanding the corporation’s risk profile and reviewing and overseeing the corporation’s management of risks;
  • reviewing and approving major changes in the auditing and accounting principles and practices to be used in preparing the corporation’s financial statements;
  • establishing and monitoring effective systems for receiving and reporting information about the corporation’s compliance with its legal and ethical obligations, and articulating expectations and standards related to corporate culture and the ‘tone at the top’;
  • understanding the corporation’s financial statements and monitoring the adequacy of its financial and other internal controls, as well as its disclosure controls and procedures;
  • evaluating and approving major transactions such as mergers, acquisitions, significant expenditures and the disposition of major assets;
  • providing advice and counsel to senior management;
  • reviewing the process for providing adequate and timely financial and operational information to management, directors and shareholders;
  • establishing the composition of the board and its committees, board succession planning and determining governance practices;
  • retaining independent advisers to assist the board and committees;
  • assessing the effectiveness of the board, its committees or individual directors; and
  • performing such other functions as are necessary.

Continue reading

Agency question from student

Hello Professor, I had a quick question regarding agency law, or more specifically the ratification portion.


Principal will be liable to a third party for an unauthorized contract entered on its behalf, if the principal accepts benefits of the contract. The principal must have knowledge of the contract, the terms and nevertheless accept the benefits.

Does this mean that the principal, after giving either actual (implied or express) or apparent authority, and having knowledge of the contract its terms and its acceptance be ratified or must it be that he must have knowledge of the contract and terms and be required to accept the benefits?

Response: Continue reading

Nice Discussion of Shareholder Proposals

We did not spend much time on this in class.  We discussed that anyone seeking a proxy in a public corporation must first prepare a “proxy solicitation statement” which has a huge amount of information and is therefore very expensive to prepare.  Shareholders therefore can ask the corporation to include a proposal into the proxy solicitation statement that the company is preparing anyway.   The BOD can refuse to do that on specific grounds.  Below is a nice discussion of the shareholder proposal rules. Continue reading

Nice Article on How to Keep Board Minutes – Some Thoughts on Board Meetings

“A well-documented board meeting creates an important historical record that can guide future deliberations and may prove useful during Board disagreements, litigation, Attorney General investigations, other governmental enforcement actions, or an audit by the IRS.”

The article, A Minute Guide to Minutes, by Patterson Belknap Webb & Tyler LLP – Justin Zaremby and Tomer J. Inbaris is here.  

Many students struggle in Biz Orgs because they cannot conceptualize a board meeting.  I have tried to figure out how to have a board meeting in class or a part of a board meeting.  I once had a make believe board meeting where the CEO of a very successful company demanded a huge bonus or she would quit.  She left the room so the board members (the class) could deliberate.  The corp was very profitable and the bonus would not “hurt” the corp.  The CEO was a big part of the reason for the success of the company.  After some discussion, I passed around 3×5 cards and had everyone vote in secret.  The vote was overwhelmingly to reject the requested bonus – all but unanimous.

I then “advised’ the CEO out in the hall of the rejection – and she “advised” me that she quit and left in a huff.  Now there are shareholders who are saying that the board blew it by letting her leave.  Profit is down.

What result?   What would go in the minutes?  What would you, as a board member, want in the minutes?

Stockholder’s Demand for Books and Records

Nice discussion of a shareholder’s rights to review a corporation’s books and records, by K&L Gates.    The article is here.  The basic rule is that a shareholder may review books and records if he has a “proper purpose.”  The article discusses the recent case of Haque v. Tesla Motors, Inc., C.A. No. 12651-VCS (Feb. 2, 2017) where the Delaware Court refused to order Tesla to turnover certain records saying :

The Court acknowledged that use of corporate records to investigate potential wrongdoing or mismanagement at a company is a proper purpose under Section 220.  However, before compelling production of records in such cases, the Plaintiff must present evidence to establish a “credible basis” from which the Court can infer that mismanagement, waste, or wrongdoing may have occurred.

The opinion is here.

More Thoughts on Laker Family Feud

Two more things have caught my eye about the Laker feud which provide me a teaching moment for my Biz Org students.

Thing one is that according to some ESPN blog, AEG is a minority owner that “controls” two seats on the corporate board of directors.   The BOD remember is Jeanie, Johnny, and Joey Buss and two others.  I’m not sure how AEG “controls” the two seats.  It is either because it owns enough shares to vote in two seats using cumulative voting, or there is some shareholders agreement between the Buss Trusts and AEG that gives AEG two seats (completely enforceable as it would relate to voting at a shareholder meeting), or there could be more than one class of stock which allocates the board seats among the classes.

Thing two is that I heard someone this morning on the radio assuring everyone that “the documents” make it clear that Jeanie is firmly in control of the Lakers.    As I said in the last blog, she seems to be firmly in control as the “controlling owner” for NBA participation purposes, but why can’t AEG use its two board seats to support Johnny and Joey and Jim and appoint someone else as President of the Lakers corp leaving her on the board.  Unless the corp is a “statutory closed corp” in California, a shareholder’s agreement making Jeanie the President is unenforceable.  The BOD must do that.  Why can’t AEG join with Johnny etc to make someone else the “controlling owner”?  I assume they can but that would apparently violate Johnny etc’s fiduciary duties owed to these trusts.  That seems to raise a serious conflict issue if Johnny cannot vote as a board member on what is best for the Lakers’ corp because of duties he owes to some trust.  And it cannot be that the BOD’s hands are tied as to removing Jeanie (again unless there is an enforceable shareholder’ agreement – enforceable being the key word in that sentence).  Continue reading

Lakers Family Dispute Offers Great Opportunity for Review of Biz Org Basics

According the L.A. Times this morning, Jim and Johnny Buss tried to take over the Lakers and “oust [Jeannie Buss] as the Lakers’ president and controlling owner.”   Jeannie Buss responded by asking the court to issue a restraining order stopping the effort and that apparently was successful.

According to the article,

Jeanie Buss [had] removed Jim Buss from his role as Lakers vice president of basketball operations and hired Magic Johnson.  Three days later, according to court documents, Johnny Buss notified his sister of a March 7 meeting to elect the team’s board of directors.  He is listed as overseeing corporate development of the Lakers.

The brothers proposed four directors, according to court records, but didn’t include her.  In order to be the controlling owner, she also must be a director.

The family trusts that own 66% of the Lakers can elect three of the board’s five members.  The trusts mandate the co-trustees — Johnny, Jim and Jeanie — take all actions to ensure Jeanie Buss remains controlling owner of the Lakers.  She has occupied the role since their father, Jerry Buss, died in 2013.

Pretty fun.  So let’s put all of this in the terms we talk about in class.   The first thing we need to know is whether this is a corporation.  I went to the business search function of the California Secretary of State and found a corporation “The Los Angeles Lakers, Inc.” formed in 1979.  The form SI indicates that Jeannie Buss is the President and there are five board members:  Jeannie, Joey and Johnny plus two other persons whose names aren’t Buss.  No Jim. Continue reading

More on Insider Trading – From Prof. Steve Bainbridge

Prof. Bainbridge has three posts on the Supreme Court Salman case.  The posts really show how unclear the concept of Tippee is.  The posts are here, here and here.

There was a 10b(5) issue on the final exam.  The “trader” was on the board of the company whose shares he was trading so he was clearly a “certain” person when he sold the shares to Zack, meaning he had a duty to disclose or not trade.  The issue was whether the “info” he had was “material non-public information.”  The info you say?  Essentially all financial info of the company that was material and non-public plus the fact that he, the seller, thought the other shareholder was lazy.