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Thursday
Dec042014

Guns, Ordinary Business, and Shareholder Proposals: Reordering the Priorities of the SEC Staff (Part 2)

We are discussing Trinity Wall Street v. Wal-Mart.

In December 2013, Trinity Wall Street submitted to Wal-Mart a shareholder proposal that called for greater oversight of products that could impair the public safety, damage the company's reputation, or offend family/community values. Specifically, the proposal sought an amendment to the charter of the Compensation, Nominating, and Governance Committee that would require: 

  • Oversight concerning the formulation and implementation of, and the public reporting of the formulation and implementation of, policies and standards that determine whether or not the Company should sell a product that:
    • 1) especially endangers public safety and well-being;
    • 2) has the substantial potential to impair the reputation of the Company; and/or
    • 3) would reasonably be considered by many offensive to the family and community values integral to the Company’s promotion of its brand.

The broad nature of the proposal notwithstanding, it was specifically intended to reach the sale of guns equipped with high capacity magazines. As the proposal stated: 

  • This oversight and reporting is intended to cover policies and standards that would be applicable to determining whether or not the company should sell guns equipped with magazines holding more than ten rounds of ammunition (“high capacity magazines”) and to balancing the benefits of selling such guns against the risks that these sales pose to the public and to the Company’s reputation and brand value.  

The supporting statement had this to say: 

  • The proposal, advanced by stockholder Trinity Church Wall Street, seeks to ensure appropriate and transparent Board oversight of the sale by the company of products that especially endanger public safety and well-being, risk impairing the company’s reputation, or offend the family and community values integral to the company’s brand.
  • The company respects family and community interests by choosing not to sell certain products such as music that depicts violence or sex and high capacity magazines separately from a gun, but lacks policies and standards to ensure transparent and consistent merchandizing decisions across product categories. This results in the company’s sale of products, such as guns equipped with high capacity magazines, that facilitate mass killings, even as it prohibits sales of passive products such as music that merely depict such violent rampages.
  • The example of guns equipped with high capacity magazines, which are on sale at the company’s stores, is instructive in other ways. There is a substantial question regarding whether these guns are well suited to hunting or shooting sports; it is beyond doubt that they are well suited to mass killing, and tragically more effective for the latter purpose, than are the handguns equipped to fire ten or fewer rounds that the company chooses not to sell except in Alaska. The former reduce opportunities for people to flee or overwhelm a shooter during reloading and have enabled many mass killings, including those at Newtown, Oak Creek, Aurora, Tucson, Fort Hood, Virginia Tech and Columbine.
  • While guns equipped with high capacity magazines are just one example of a product whose sale poses significant risks to the public and to the company’s reputation and brand, their sale illustrates a lack of reasonable consistency that this proposal seeks to address through Board level oversight. This responsibility seems appropriate for the Compensation, Nominating and Governance Committee, which is charged with related responsibilities. 

The company sought exclusion of the proposal as related to the ordinary business of the corporation. Despite the ongoing public debate over the regulation of firearms, the SEC staff agreed that the proposal could be excluded. We will look at the reasoning in the next post.  

The no action letter issued by the staff is here. We have posted the opinion in Trinity Wall Street v. Wal-Mart at the DU Corporate Governance web site.

Wednesday
Dec032014

Guns, Ordinary Business, and Shareholder Proposals: Reordering the Priorities of the SEC Staff (Part 1)

Rule 14a-8 permits shareholders to submit proposals to companies for inclusion in the proxy statement. See 17 CFR 240.14a-8. The rule, however, provides multiple grounds for excluding a proposal.  

The rule also provides a process whereby companies wanting to exclude proposals can obtain a no action letter from the staff of the SEC. The staff routinely grants these letters. In 2014, the staff acceded to the company's request to exclude proposals in 71% of the cases; in 2013, the percentage was 65%. Proposals are most often excluded because of procedural errors or are deemed by the staff to be vague or misleading.

The most common substantive basis for excluding proposals is the "ordinary business" exclusion. See Rule 14a-8(i)(7) (allowing exclusion "If the proposal deals with a matter relating to the company's ordinary business operations"). With little case law or other sources of insight, the staff has relatively broad latitude to determine whether a matter falls within a corporation's ordinary business. 

This exclusion has always been problematic. Proposals involving actions of the corporation invariably touch on the company's business and therefore arguably fall within the exclusion. In the 1950s, a proposal seeking to address segregation was excluded as ordinary business. In the 1960s, a proposal seeking to address the manufacture of napalm was excluded on this basis.

The approach changed somewhat in the 1970s when the Commission adopted what amounted to a public policy exception to the "ordinary business" exclusion. As the Commission stated back in 1976: 

  • [T]he term “ordinary business operations” has been deemed on occasion to include certain matters which have significant policy, economic or other implications inherent in them. For instance, a proposal that a utility company not construct a proposed nuclear power plant has in the past been considered excludable under former subparagraph (c)(5). In retrospect, however, it seems apparent that the economic and safety considerations attendant to nuclear power plants are of such magnitude that a determination whether to construct one is not an “ordinary” business matter. Accordingly, proposals of that nature, as well as others that have major implications, will in the future be considered beyond the realm of an issuer's ordinary business operations, and future interpretative letters of the Commission's staff will reflect that view. 

Exchange Act Release No. 19771 (Nov. 22, 1976). In effect, therefore, proposals implicating a company's ordinary business could still be excluded but not if involving matters of important public policy or debate. For a more thorough discussion of this history, see Essay: The Politicization of Corporate Governance: Bureaucratic Discretion, the SEC, and Shareholder Ratification of Auditors.

From the very beginning, however, the approach raised a number of concerns. First, there were no meaningful standards (nor have any ever been developed) that dictated when a proposal would be a matter of sufficient public concern or debate to override the ordinary business exclusion. As a result, staff decisions in this area can often seem random and subject to unexplained shifts.  

Second, the public policy exception had, at some level, the potential to eviscerate the ordinary business exclusion. Shareholders for the most part do not submit proposals that address mundane aspects of a company's business that are unimportant to the public. Instead, they deliberately select matters of interest to the public. As a result, almost every proposal implicating the ordinary business exclusion also implicates the public policy exception. 

Ultimately, it is the staff of the SEC that resolves these issues through the no action letter process. For the most part, the decisions of the staff are not subject to review (the Commission rarely accepts an appeal from a staff decision in this area). 

This dynamic may, however, be about to change. A shareholder unhappy with the staff's determination appealed to federal district court. The court rejected the staff's reasoning and enjoined the company from omitting the proposal under the "ordinary business" exclusion. 

The no action letter is here. We have posted the opinion in Trinity Wall Street v. Wal-Mart at the DU Corporate Governance web site.  

Tuesday
Dec022014

Law Review Articles, the Delaware Courts, and Some "Guidance" on Bylaws (Part 4)

We are discussing the article written by Justice Ridgely from the Delaware Supreme Court. See The Emerging Role of Bylaws in Corporate Governance. The article examines bylaws, including forum selection, fee shifting, and mandatory arbitration bylaws.   

So where does this end up?

The article was critical of those bylaws that reduced the role of the Delaware courts (fee shifting and mandatory arbitration) but positive with respect to the bylaws that enhanced their role (forum selection bylaws). The article is consistent with a view that would maximize the role of the Delaware courts in the corporate governance process.

While reflecting only the position of Justice Ridgely ("Before I begin, I need to say that the views I give you are my own and do not necessarily reflect the views of my colleagues or the Delaware Supreme Court."), one suspects the full court would fully agree with his views.

Monday
Dec012014

Law Review Articles, the Delaware Courts, and Some "Guidance" on Bylaws (Part 3)

We are discussing the article written by Justice Ridgely from the Delaware Supreme Court. See The Emerging Role of Bylaws in Corporate Governance.  The article examines bylaws, including forum selection, fee shifting and mandatory arbitration bylaws.   

The article also took a dim view of bylaws that mandated arbitration and eliminated the right to bring class actions.  As the article noted:

  • Another category of bylaw generating discussion, but not yet litigation in Delaware, is a mandatory arbitration bylaw covering intra-corporate disputes that waives a shareholder’s right to a class action. Some commentators have concluded that a board has the unilateral power to do this after the Boilermakers decision.  However, in Boilermakers, then-Chancellor Strine expressly noted that the bylaw at issue did not regulate whether the stockholder may file suit.

Similarly, bylaws were suspect to the extent cutting off the right of shareholders to bring derivative actions.

  • Moreover, a significant issue exists as to whether a bylaw, unilaterally adopted by a board, that eliminates the equitable standing of a stockholder to sue derivatively on behalf of a corporation is per se an inequitable purpose under an ATP analysis. In Schoon v. Smith, the Delaware Supreme Court traced the historic origins in equity of the derivative action to the 14th century in England. “To prevent ‘a failure of justice,’ courts of equity granted equitable standing to stockholders to sue on behalf of the corporation ‘for managerial abuse in economic units which by their nature deprived some participants of an effective voice in their administration.’” The policy foundation for this is the ancient maxim that equity will not suffer a wrong without a remedy. Our Court of Chancery has explained that “[t]he derivative action was developed by equity to enable stockholders to sue in the corporation’s name where those in control of the corporation refused to assert a claim belonging to the corporation.” Whether or not arbitration and a class-action waiver would be upheld when equitable standing to bring a derivative suit was designed “to set in motion the judicial machinery of the court,” likely will be a central issue in litigation over the validity of such an arbitration bylaw in Delaware.

Although unmentioned in the article, these are the same type of bylaw that drew objection from the SEC in a recent IPO.  See Carlyle Drops Arbitration Clause From I.P.O. Plans

Friday
Nov282014

Law Review Articles, the Delaware Courts, and Some "Guidance" on Bylaws (Part 2)

We are discussing the article written by Justice Ridgely from the Delaware Supreme Court. See The Emerging Role of Bylaws in Corporate Governance. The article examines bylaws, including forum selection, fee shifting, and mandatory arbitration bylaws.   

With respect to forum selection bylaws, the articles was very positive. It noted the growing popularity of these bylaws (citing one source that found "at least another 112 Delaware corporations adopted or announced plans to adopt exclusive forum bylaws"). The article also noted their widespread acceptance outside of Delaware. See id. ("Jurisdictions in addition to Delaware have recognized the validity of a Delaware corporation’s forum-selection bylaw. As of this point, courts in California, Illinois, Louisiana, New York, Texas, and Ohio have upheld forum-selection bylaws adopted by Delaware corporations.").      

The article did not mention the two cases that have declined to apply the bylaws. See Roberts v. Triquint Semiconductor, Inc., Circuit Court of Oregon, Aug. 14, 2014 & Galaviz v. Berg, US D. Ct., ND CA, Jan. 3, 2011.      

With respect to fee shifting bylaws, the article was much more negative, raising all kinds of concerns. There was the problem of enforceability.   

  • Even though the Court found that a fee-shifting bylaw is not per se prohibited under Delaware law, this does not mean that a fee-shifting bylaw will be enforced. Rather, the enforceability of a bylaw in a court of equity "depends on the manner in which it was adopted and the circumstances under which it was invoked. Bylaws that may otherwise be facially valid will not be enforced if adopted or used for an inequitable purpose. Thus, “the enforceability of a facially valid bylaw may turn on the circumstances surrounding its adoption and use. For example, in Schnell v. Chris–Craft Industries, the Delaware Supreme Court refused to enforce a board-adopted bylaw that sought to reschedule the annual stockholder meeting for a month earlier. The Court held that the board’s intention in moving the meeting was to “perpetuat[e] itself in office” and "obstruct[] the legitimate efforts of dissident stockholders in the exercise of their rights to undertake a proxy contest against management.”

The article further suggested the reasoning in the ATP decision (the case upholding fee shifting bylaws) would not be extended to for profit companies.   

  • Since the Court’s decision in ATP Tour, a number of commentators have assumed that it applies equally to for-profit, stock corporations. The Delaware Supreme Court did not say that in ATP Tour, so this remains an open question. 

Finally, the article indicated that bylaws providing for the payment of fees only by shareholders were particularly suspect.   

  • Several companies have adopted one-way fee-shifting bylaws in the wake of ATP Tour despite the current uncertainty surrounding their validity. For example, a number of IPO’s have adopted fee-shifting bylaws, including: Alibaba, Smart & Final, and ATD Corp. These bylaws purport to make investors liable for all litigation-related costs of the defendants, unless the investors obtain a judgment on the merits that substantially achieves, in substance and amount, the full remedy sought. Not surprisingly, they are being challenged when they are raised before the Delaware Court of Chancery.

Perhaps recognizing the risk of this type of challenge, some companies (Smart & Final) have eschewed bylaws in favor of amendments to the articles/certificate.

Thursday
Nov272014

Law Review Articles, the Delaware Courts, and Some "Guidance" on Bylaws (Part 1)

We have discussed before the unusual predilection of those on the Delaware courts to speak and write about topics that will invariably come before them.   

The phenomena of providing "guidance" through mechanisms outside of the judicial process has been encouraged. See Myron Steele & J.W. Verret, "Delaware's Guidance: Ensuring Equity for the Modern Witenagemot, 2 Virginia Law & Business Review 189 (2007) ("The Delaware courts recognize the need to wait for a live controversy to resolve an issue definitively, but fortunately they also recognize that this does not mean that they cannot, or should not, use the attention paid to a published opinion to offer guidance on uncertain but vital areas of corporate law."). Moreover, the courts cite articles written by their bretheren as authority. (A post on the subject is here). 

One very topical area under Delaware law has been the use of bylaws to affect judicial process. Forum selection bylaws and fee shifting bylaws are the two most notable examples. As it turns out, a Justice of the Delaware Supreme Court has just written a piece (based upon a speech) on this very topic. See Justice Ridgely, The Emerging Role of Bylaws in Corporate Governance. The article not only discusses bylaws in general but comments specifically on forum selection and fee shifting bylaws. We will see what Justice Ridgely has to say about these bylaws in the next post.

Wednesday
Nov262014

Hensley v. IEC Electronics Corp.: Scienter and the Core Operations Doctrine

In Hensley v. IEC Electronics Corp., No. 13-CV-4507, 2014 BL 252726 (S.D.N.Y. Sept. 11, 2014), the United States District Court for the Southern District of New York granted defendants’ motion to dismiss and denied plaintiffs’ claims under Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 (the “Exchange Act”) and SEC Rule 10b-5. 

According to the allegations in the complaint, IEC Electronics Corporation (“IEC” or the “Company”) is a publicly traded Delaware corporation that provides electronic contract manufacturing services. In December 2010, IEC acquired Southern California Braiding, Inc. (“SCB”) for approximately $26 million. Thereafter IEC began to integrate SCB into the Company. 

In late 2011 and early 2012, SCB allegedly began to show signs of trouble; however, IEC and Defendant W. Barry Gilbert, IEC’s Chief Executive Officer and Chairman of its Board of Directors, allegedly continued to make statements representing SCB’s performance as generally strong. In May 2013, IEC disclosed an accounting error in which work-in-process inventory was reported as inventory available for sale. The mistake, IEC indicated, required a restatement of the Company’s quarterly reports and financial statements for the 2012 fiscal year. The error in SCB’s consolidated financial statements “resulted in ‘an aggregate understatement of cost of sales and an aggregate overstatement of gross profit during all such [r]estated [p]eriods,’ totaling $2.2 million.” 

Following IEC’s disclosure, share prices declined approximately 13.23% in two days and continued to fall over the next few weeks. IEC explained the error by pointing to internal weaknesses in control over financial reporting. The Company also stated that, although various remedial measures had been instituted, the reporting issues could not be considered completely mitigated until the corrective processes had been in place long enough to demonstrate their effectiveness.

Plaintiffs Kevin Doherty, Raymond Jean Hensley, and Niraj Jetly (collectively the “Plaintiffs”) filed a Consolidated Class Action Complaint on November 15, 2013, alleging that defendants IEC, Gilbert, Vincent A. Leo, IEC’s interim Chief Financial Officer (“CFO”), (collectively the “Defendants”), violated Section 10(b) of the Exchange Act. Plaintiffs also alleged that Defendants Gilbert and Leo violated Section 20(a) of the Exchange Act through their acts and omissions as people in controlling positions of the company. In response, Defendants filed a motion to dismiss. 

Allegations of securities fraud must satisfy the heightened pleading standards of the Private Securities Litigation Reform Act (“PSLRA”). The PSLRA requires that a plaintiff plead scienter with particularity, and state facts giving rise to a strong inference that the defendant acted with the requisite state of mind. In the Second Circuit, this can be done by alleging facts showing that the defendants had opportunity and motive to commit the fraud, or by alleging facts establishing strong circumstantial evidence of conscious misbehavior or recklessness. 

Plaintiffs relied on the latter theory, basing their argument in large part on the core operations doctrine. Under the doctrine, the senior executives of the company are presumed to be knowledgeable about critical information having to do with the company’s long-term viability. As a result, allegedly false or misleading statements concerning the core operations of the company give rise to an inference that the defendants knew or should have known the statements were false when made. 

The court rejected Plaintiffs’ argument. The court declined to find that the statements about the SCB acquisition fell into the “core operations” of the Company. Although the acquisition was expensive, SCB consisted only of about 15% of IEC’s total revenue and did not, therefore, “ ‘constitute nearly all’ of IEC’s business.” Additionally, the court stated the practice of accounting for work-in-process inventory was not a core operation of IEC, let alone SCB.  

The court also found that Plaintiffs fell “far short of alleging ‘conduct which is highly unreasonable and which represents an extreme departure from the standards of ordinary care.’ ”

Therefore, the Plaintiffs merely alleged “an accounting error, however substantial, that was highly technical in nature; did not affect the company as a whole; and was discovered, disclosed, and corrected by Defendants themselves.”

Accordingly, the court granted the Defendants’ motion to dismiss and dismissed the complaint in its entirety.

The primary materials for this case may be found on the DU Corporate Governance website.

Tuesday
Nov252014

Forum Selection Bylaws: The Elephant in the Room

Forum selection bylaws are ostensibly designed to prevent the inefficiencies that arise out of the filing of multiple derivative actions in multiple jurisdictions. See North River Insurance Co. v. Mine Safety Appliances Co., --- A.3d --- n. 75 (Del. Nov. 6, 2014) ("In the corporate context, for example, much of the discussion has centered on ways in which corporations have responded to multi-forum litigation, such as the adoption of forum-relation charter or bylaw provisions.").  See also The Honorable Henry duPont Ridgely, Justice, Supreme Court of Delaware, The Emerging Role of Bylaws in Corporate Governance, ("Notwithstanding the policy of the Council of Institutional Investors against forum section clauses, the number of corporate boards that are adopting forum selection bylaws to avoid the risk of costly shareholder suits in multiple jurisdictions continues to grow.")  

While that certainly represents one basis for adopting forum selection bylaws, another is to ensure that the case is heard before a judiciary where the outcome is management friendly. 

In Wolst v. Monster Beverage, the issue was whether the inspection request should be denied because the underlying conduct that could result in a derivative action was outside the statute of limitations.  One issue discussed at the relevant hearing was whether the statute of limitations issue should be determined in an action under DGCL 220.  

In asserting that the issue should not be resolved in connection with the request to inspect, counsel for plaintiff had this to say: 

  • if a derivative case were brought, it could be brought in Delaware. It might possibly be brought in California state court or California federal court. While the law that would govern this case would be the exact same case, it would be Delaware substantive law because Monster is a Delaware corporation, there might or might not be different tolling practices or procedures or case law that a judge would refer to in that ultimate action. 

In other words, while the substantive law would remain the same, decision makers outside of Delaware might have a different view on the application of the law.  Forum selection bylaws, however, interfere with the ability of shareholders to select decision makers that may have this alternative perspective.  

For primary materials related to Wolst, go to the DU Corporate Governance web site.

Monday
Nov242014

The SEC and the Unexpected Role of the Founding Fathers

The American Association of Law Schools announced with great excitement that Mary Jo White, the current chair of the SEC, would be the inaugural speaker for the Showcase Speaker series. She is due to address the AALS on January 3, 2014.

From AALS description of Chair White, she should have some very interesting, indeed unique, observations to make. Here is what the AALS had to say

  • Join us at the inaugural AALS Showcase Speaker program with U.S. Securities and Exchange Commission Chair Mary Jo White. She is the only woman to hold the top position in the more than 200-year history of the SEC. She is also an experienced federal prosecutor and securities lawyer.  

The statement deserves a few observations. 

First, Mary Schapiro, who served as SEC Chair from 2009 through 2012 would be very surprised to learn that Chair White was the "only woman to hold the top position." In fact, Chair Schapiro was both the first permanent woman chair (2009) and the first temporary woman chair (1993). Elisse Walter, the second permanent woman chair, would also likely be surprised.    

Second, the SEC has a long and storied history but its roots do not go back 200 years. That would put the creation of the SEC in 1814, smack in the midst of the War of 1812. With Washington occupied that same year, the British burned the capital, something that would likely have prevented the creation of the SEC, even had it been contemplated. The founding father of the SEC is Franklin Roosevelt (the agency was created in 1934) not James Madison. The AALS notwithstanding, the SEC cannot tie its roots to the heroes of the Revolutionary War period.

The Chair will no doubt have interesting things to say, as always, but she won't be including any insights arising from her service as "the only woman to hold the top position" and she won't be including any thoughts on the "more than 200 year history of the SEC."    

Friday
Nov212014

Conflict Minerals: On We Go: Challenge to be Heard by Full Court

On November 18, the United States Court of Appeals for the District of Columbia agreed to reconsider the last ruling in the on-going dispute of Section 1502 of Dodd-Frank and the implementation of the SEC's conflict minerals rule (the “Rule”) (discussed here , here, and here). The full court granted a request for re-hearing made by the SEC and Amnesty International, which intervened on the side of the agency. Specifically, the re-hearing request argued that re-consideration was necessary in light of the ruling in en banc decision in American Meat Institute v. USDA, 2014 BL 208501 (29 CCW 252, 8/13/14), because that case “expressly overruled a portion of the panel's First Amendment opinion in this case.” Accordingly, “American Meat makes clear that panel or en banc reconsideration of the panel opinion is necessary."

Not surprisingly, the groups challenging the Rule, including the National Association of Manufacturers, the United States Chamber of Commerce and the Business Roundtable, said the American Meat Institute ruling should not change the outcome of the conflict minerals decision.

 

  • “Indeed, the en banc court specifically distinguished purely factual and uncontroversial disclosures, which may be permissible, from unconstitutional compelled speech about controversial matters, which is precisely what the Conflict Minerals Rule requires,” the statement said. “The Conflict Minerals Rule remains costly, counterproductive, and unconstitutional, and we will continue to oppose it in the courts, the SEC, and in Congress.” 

 

And so the fight goes on. The per curiam order of the Circuit Court directs the parties to file supplemental briefs addressing the following specific questions related to the First Amendment issue:

(1) What effect, if any, does this court’s ruling in American Meat Institute v. U.S. Department of Agriculture, 760 F.3d 18 (D.C. Cir. 2014) (en banc), have on the First Amendment issue in this case regarding the conflict mineral disclosure requirement?

(2) What is the meaning of “purely factual and uncontroversial information” as used in Zauderer v. Office of Disciplinary Counsel, 471 U.S. 626 (1985), and American Meat Institute v. U.S. Department of Agriculture, 760 F.3d 18 (D.C. Cir. 2014) (en banc)?

(3) Is determination of what is “uncontroversial information” a question of fact?

No date has been set yet for the rehearing at the appeals court.

Thursday
Nov202014

Judicial Rewriting of Inspection Rights: Wolst v. Monster Beverage Corp. (Part 3)

We are discussing Wolst v. Monster Beverage, an action brought under DGCL 220.  

The case is both inconsistent with the purpose of Section 220 and inconsistent with prior Delaware law. 

The Shareholder sought to engage in the inspection to obtain the underlying documentation that addressed the special committee’s recommendation to deny the litigation request. The court, however, recast the purpose as the desire to obtain the information needed to bring a derivative suit.    

  • In summary, Wolst “has articulated no stated purpose other than to investigate wrongdoing in order to bring [her derivative] suit against [Monster's insiders who traded on nonpublic information], and [Wolst] is time-barred from bringing that suit.” Accordingly, because the derivative action contemplated by Wolst would be time-barred and because no other purpose has been identified, she has failed to prove a proper purpose, an essential element of her case under Del. C. § 220.   

There is little doubt, as is often the case, that Shareholder sought books and records to assess the viability of a derivative suit. The requirement of a “proper purpose” does not, however, turn on the ultimate use of the documents but on the purpose of the inspection. For that, shareholders need only have a purpose that is “reasonably related to such person's interest as a stockholder.” 

Obtaining insight into the special committee's investigation regarding allegations of insider trading and the reasons for the denial of the litigation request could have provided useful information in a number of respects. The information may have resulted in Shareholder deciding not file a suit but instead negotiating with management over a stronger policy concerning insider trading. The actions of the special committee and the board could have cast light on the competency of directors, influencing future voting decisions by Shareholder. In other words, the information was potentially useful to Shareholder irrespective of the filing of a derivative suit.

None of these possible uses mattered in the court's analysis. Instead, the court essentially found the documents sought in the inspection request had only a single purpose: use in a possible derivative suit. While it is true that Shareholder indicated this as a goal, the reality is that only after completion of the inspection could Shareholder decide on the the appropriate next step, only one of which would have been the filing of a derivative suit. The idea that the inspection might have resulted in no litigation and generated useful dialogue between Shareholder and management was not something the court even considered (or encouraged).  

Moreover, the analysis effectively whipsaws shareholders in inspection rights cases. In other instances, shareholders have seen their requests to inspect dismissed because they wanted to use the documents in a derivative suit. In Central Laborers Pension Fund v. News Corporation, No. 6287-VCN, 2011 WL 6224538 (Del. Ch. Nov. 30, 2011) (aff'd on other grounds), the Chancery Court effectively found that shareholders lacked a proper purpose because shareholders had sought to inspect only after filing a derivative suit. The court viewed the use of inspection rights as a substitute for discovery as not a proper purpose.  

So if shareholders want documents to advance a derivative claim, they risk dismissal. This encourages the invocation of a purpose that is broader than simply promoting a derivative suit. Yet as Wolst shows, even where a broader purpose is alleged, courts are open to simply recharacterizing the purpose as promoting a derivative suit and using that as a basis for dismissal.     

Primary materials on this case, including the opinion of the Vice Chancellor, can be found at the DU Corporate Governance web site.

Wednesday
Nov192014

Judicial Rewriting of Inspection Rights: Wolst v. Monster Beverage Corp. (Part 2)

We are discussing Wolst v. Monster Beverage Co., a case brought under DGCL 220.  

The case arose out of insider trading allegations that occurred in 2007. A derivative action over the behavior was filed in 2008 and a shareholder ("Shareholder") intervened. The action was dismissed in 2011 for the failure to establish demand futility. In 2012, Shareholder demanded the board "(i) investigate possible violations of law; and (ii) commence a civil action against the officers of the Company for the misconduct identified." Verified Complaint, at 20.

The board then formed a special committee. On October 19, 2012, Shareholder was notified that her demand had been rejected. In March 2013, Shareholder filed a request for inspection. The purpose was identified as:  

  • (1) “[e]valuating the Board's refusal to act on [her] litigation demand and whether that refusal constituted a reasonable and good-faith exercise of the Board's business judgment” and (2) “[e]valuating the process by which the Board decided to refuse to act on [her] litigation demand.”  

In effect Shareholder wanted documents to determine whether the board had an adequate basis for refusing her demand. As part of that, Shareholder presumably expected to obtain information on the investigation into the alleged misbehavior, thus allowing her to determine the steps taken by the board other than the refusal to engage in litigation.   

Of course, one result was the possibility that Shareholder would file suit to challenge the decision to refuse the litigation demand. Indeed, Shareholder conceded “that her ultimate goal in pursuing her books and records request is ‘to determine whether there is a basis to bring a derivative suit’ based on the ‘wrongs alleged in’ the earlier derivative action.” The court described the “end game” as a derivative suit.  

The company asserted that any derivative claim based upon the allegations from 2007 were barred by the statute of limitations. Such a defense did not automatically bar an inspection. As the court noted:  

  • A potentially viable affirmative defense to an anticipated derivative claim will not necessarily defeat a books and records effort. Sometimes developing the record to withstand possible affirmative defenses requires more effort than is practicable for a books and records action. Sometimes conduct that cannot be challenged because of a time-barr defense can, nevertheless, inform consideration of other potentially wrongful conduct that is not yet time-barred.    

Nonetheless, this is not always the case.  

  • There is, however, “the possibility that, in a specific factual setting, a time bar defense . . . would eviscerate any showing that might otherwise be made in an effort to establish a proper shareholder purpose.” The challenged trading activities occurred in 2006 and 2007. [Shareholder] does not identify any more recent potentially wrongful conduct that could provide a basis for a derivative action. Without some elaboration upon what she would do with the requested books and records in her capacity as a stockholder, the burden of producing books and records that Section 220 imposes upon the corporation should be avoided in this instance. In sum, consideration of a time-bar defense to the contemplated derivative action is appropriate in this “specific factual setting.”  

Shareholder challenged the court's decision to resolve the statute of limitations issues (resolving such issues as the application of laches) in a 220 hearing. Nonetheless, the court found the statute of limitations applied and, therefore, Shareholder lacked a proper purpose.  

Primary materials on this case, including the opinion of the Vice Chancellor, can be found at the DU Corporate Governance web site. 

Tuesday
Nov182014

Judicial Rewriting of Inspection Rights: Wolst v. Monster Beverage Corp. (Part 1)

When it comes to inspections rights, shareholders in Delaware, for the most part, cannot win.  

Section 220 of the Delaware General Corporation Law provides shareholders with inspection rights. The provision imposes some process requirements (the request has to be in writing) and requires a proper purpose.

The Delaware courts have, however, used this simple statutory framework to throw up a substantial number of barriers that effectively deny shareholders access to corporate books and records.   

First, the "form and manner" requirements are to be interpreted narrowly, even in circumstances that seem to defy common sense. See Cent. Laborers Pension Fund v. News Corp., 45 A.3d 139 (Del.  2012).   

Second, the courts have grafted onto Section 220 a requirement that shareholders provide a "credible basis" for any proper purpose alleged. In effect, this requires shareholders to find affirmative evidence of mismanagement in the public domain, a standard often difficult to meet given the process nature of most fiduciary duty claims.  

Third, the statute requires shareholders to have a “proper purpose” for inspecting any records. Although the statute provides that this is any purpose “reasonably related” to a shareholder's interest, the courts have, for the most part, defined a proper purpose only as corporate waste, mismanagement, or other wrongdoing. It is as if the only interest shareholders have in the assets they own is whether management engaged in improper behavior. 

In Wolst v. Monster Beverage Corp. the Chancery Court added another barrier. The court essentially found that the purpose was less relevant than that intended use of the materials. Although the shareholder seeking the right to inspect had what would seem, on its face, a proper purpose (to understand why a special committee denied the demand request), the court found the intended use was a derivative suit. Because the derivative suite was barred by the statute of limitations, the court denied the right to inspect.

We will discuss this case in the next several posts.

Primary materials on this case, including the opinion of the Vice Chancellor, can be found at the DU Corporate Governance web site. 

Monday
Nov172014

Securities and Exchange Commission v. Braverman: SEC Seeks Emergency Asset Freeze  

The Race to the Bottom previously posted on the complaint filed by the Securities and Exchange Commission (“SEC”) against Dmitry Braverman (“Braverman”), alleging that Braverman made $300,000 in illicit profits from an insider trading scheme. This post examines the SEC’s motion for an emergency asset freeze. The SEC argued for emergency relief to prevent Braverman and relief defendant Vitaly Pupynin (“Pupynin”) from moving the allegedly illicit assets out of the reach of the SEC and the courts.

In a memorandum of law filed on September 17, 2014 (the day after the complaint was filed), the SEC set forth arguments supporting its emergency application for an order freezing the assets of both Braverman and Pupynin, repatriating the assets that were moved abroad, and prohibiting Braverman and Pupynin from destroying documents.

The SEC argued it could meet the standard required to obtain a freeze of Braverman’s assets; that standard requires it to show “either a likelihood of success on the merits, or that an inference can be drawn that the party has violated the federal securities laws.”

First, the SEC argued it will likely win its Section 10(b) and Rule 10b-5 insider trading claims against Braverman, and “at a minimum, an inference can be drawn that Braverman violated those provisions.” Second, the SEC argued it will likely win its claims under Section 14(e) and Rule 14e-3, which address instances of insider trading involving tender offers. The SEC alleged Braverman had begun moving his assets out of the reach of the SEC and the court, and argued a freeze is necessary to ensure the SEC will be able to collect any final judgment it obtains. According to the SEC, Braverman may ultimately be liable for more than $1.2 million, including disgorgement, prejudgment interest, and penalties.

Additionally, the SEC argued it could also meet the standard required to obtain a freeze of Pupynin’s assets; that standard requires the SEC to show Pupynin “(1) has received ill-gotten funds; and (2) does not have a legitimate claim to those funds.” Pupynin, named as a relief defendant, is a close relative of Braverman and a resident and citizen of Russia. The SEC alleged Braverman used brokerage accounts in Pupynin’s name and illicit profits were wired to bank accounts in Pupynin’s name.

The SEC also sought an order repatriating the illicit profits Braverman and Pupynin had already moved abroad. The SEC alleged that some of Braverman’s illicit profits have already been wired to a bank account in Latvia and repatriation was necessary to effect the asset freeze.

The SEC additionally sought to prohibit Braverman and Pupynin from altering, destroying, or concealing any documents.

The primary materials for this post can be found on the DU Corporate Governance website at: Plaintiff Securities and Exchange Commission’s Memorandum of Law in Support of its Emergency Application for an Asset Freeze and Other Relief, Sec. & Exch. Comm’n v. Braverman, No. 1:14-CV-07482-RMB (S.D.N.Y. Sept. 17, 2014).

Friday
Nov142014

JOBS Act Isn’t Effective According to Academic Study Findings

Jumpstart Our Business Startups Act (“JOBS Act”) was signed into law in April 2012 with the intent of reducing the cost and regulatory burden for small firms seeking to raise capital in both private and public markets. The JOBS Act provides for a stream-lined initial public offering (“IPO”) process for a new type of company called “emerging growth company” (“EGC”).

An EGC generally includes companies with less than $1 billion in revenues in the most recently completed fiscal year. Title I of the JOBS Act creates a so-called IPO “on-ramp” designed to lower the cost of raising capital. The “on-ramp” reduces the mandated disclosure and compliance obligations for EGCs during the IPO process and the first few years as a public company. A recent academic study indicates, however, that these goals are not being achieved.

A study examined 213 EGC IPOs that occurred between April 2012 and April 2014. See “The JOBS Act and the Costs of Going Public.” According to the study’s findings, there is little evidence that the JOBS Act effectively lowered the cost or increased the volume of IPOs.

The study found “no evidence” that EGC status resulted in a reduction of “direct costs of issue, such as accounting, legal, or underwriting fees.” In addition, the “lower mandated disclosure” resulted in less transparency and greater underpricing (an offering price significantly lower than the price of the first trade). 

The study indicated, however, that greater underpricing was present only for larger firms that were “newly eligible for reduced disclosure and delayed compliance.” As for smaller companies, the study found “no evidence” that they experienced “any change in their cost of capital.” Overall, the study concluded that the JOBS Act did little, if anything, to increase the number of IPOs. The lack of increase in overall IPO volume is consistent with the findings that the benefits of the JOBS Act are outweighed by higher costs of capital.

Thursday
Nov132014

Delaware and the Consequences of an Excessively Management Friendly Approach to Corporate Governance (Part 2)

The notion that Section 109 permitted bylaws that regulated judicial (or presumably regulatory) process opened the door to bylaws that went well beyond those that shifted fees. 

Nothing in the analysis prohibited a company from adopting a bylaw that, for example, imposed fees on shareholders that submitted an unsuccessful proposal under Rule 14a-8. 

Nothing in the analysis prevented the adoption of a bylaw that shortened the time period for a shareholder to answer a counterclaim. None of these areas truly involved the internal affairs of a corporation and were, therefore, beyond the realm of regulation in bylaws. Yet Delaware imposed no such limit.   

The results of this approach can be seen from the bylaw adopted by Imperial Holdings. Rather than adopt a fee shifting bylaw, the company adopted a bylaw that restricted derivative actions by shareholders by imposing a minimum ownership threshold to bring an action. As the provison provides:

  • Representative Claims. Except where a private right of action at a lower threshold than that required by this bylaw is expressly authorized by applicable statute, a current or prior shareholder or group of shareholders (collectively, a “Claiming Shareholder”) may not initiate a claim in a court of law on behalf of (1) the corporation and/or (2) any class of current and/or prior shareholders against the corporation and/or against any director and/or officer of the corporation in his or her official capacity, unless the Claiming Shareholder, no later than the date the claim is asserted, delivers to the Secretary written consents by beneficial shareholders owning at least 3% of the outstanding shares of the corporation as of (i) the date the claim was discovered (or should have been discovered) by the Claiming Shareholder or (ii), if on behalf of a class consisting only of prior shareholders, the last date on which a shareholder must have held shares to be included in the class.

The provision applies to derivative actions but also apparently applies to federal class action lawsuits under the federal securities laws (since these are brought against the corporation). Moreover, the provision breaks new ground by providing that, as a condition for filing a law suit in state or federal court, plaintiffs must deliver proof of ownership to the company. 

According to the company's press release, the bylaw was designed to "ensure that any shareholder filing a lawsuit on behalf of the company or a class of shareholders has a minimum degree of shareholder support and adequately represents shareholders' interests." The company indicated that the bylaw would be submitted "to shareholders for ratification at the next annual meeting." As the release set out:  

  • Phillip Goldstein, Imperial's chairman and a principal of Bulldog Investors, its largest shareholder commented: "The Board has noticed a disturbing trend of lawsuits brought by shareholders with very small stakes in publicly traded companies against the companies, their directors, and their officers, purportedly on behalf of a class of shareholders or on behalf of the company. These lawsuits often result in other shareholders receiving no meaningful benefit and indirectly incurring the cost of the plaintiff's lawyer and the company's lawyer. The Board believes it is in the best interest of the company to require a shareholder claiming to represent a class of shareholders or the company to demonstrate a minimum level of shareholder support."

This provision may not survive a judicial challenge (it should cause significant pause even in Delaware). The courts will likely take a dim view of limits on their jurisdiction that take the form of mandatory filings with the corporation. Moreover, the bylaw effectively eliminates the right of small shareholders to bring derivative and securities class action law suits, at least for shareholders and former shareholders who lack the resources needed to obtain the necessary consent.    

Nonetheless, the bylaw demonstrates the consequences of an approach taken by Delaware courts that authorized bylaws affecting judicial process. It suggests that companies will use this new found discretion to adopt a wide variety of bylaws that seek to restrict access to the courts. Moreover, these bylaws impose costs. In marginal cases, shareholders may not bring actions. In other instances, they raise the costs associated with litigation, either through the need to assemble a 3% block or through the need to challenge the validity of the bylaw.   

There are two ways out of this quagmire. First, the Delaware courts can impose meaningful limits on these types of bylaws. The idea that anything goes under Section 109 could and should be revisited and serious limits imposed on bylaws that effectively restrict access to the courts. While the Delaware courts will probably impose some limits eventually, there is no reason to believe that they will be meaningful.  

The other way out is through federal preemption. Congress can have, at the ready, a provision that prohibits bylaws that interfere with judicial process. The law ought to apply to all public companies (the say on pay model) but could also be applicable to exchange traded companies (the audit/compensation committee approach). In any event, the management friendly approach taken by the Delaware courts with respect to these bylaws invites further federal preemption, an unfortunate but obvious consequence of the interpretation. 

Wednesday
Nov122014

Delaware and the Consequences of an Excessively Management Friendly Approach to Corporate Governance (Part 1)

As we have noted before on this Blog, there was a time when the Delaware courts, albeit always management friendly, occasionally made decisions favorable to shareholders.  Van Gorkom and Unocal are two examples.  Those days are over. 

A bylaw friendly to shareholders that sought reimbursement for shareholders who successfully elected a director?  Struck down.  A bylaw favorable to management forcing shareholders to litigate cases in a designated forum (mostly Delaware), upheld.  Inspection rights denied because documents were going to be used in litigation (see the lower court case in Central Laborers Pension Fund v. News Corp); inspection rights denied because documents could not be used in litigation (due to the statute of limitations) (Wolst v. Monster Beverage).  

Cases that benefited shareholders in the past (Blasius) are under attack and not likely to survive much longer.  Standards in mergers with controlling shareholders have been weakened, with entire fairness replaced in some cases by the business judgment rule.  Process continues to replace substance yet the process is given little meaning (except perhaps in Vice Chancellor Laster's courtroom). 

The most obvious consequence of this approach has been efforts by shareholders and investors to seek reform in other forums.  For the most part, this has meant appeals to, and preemption by, Congress.  Congress intervened and set standards for audit and compensation committees of the board.  Congress intervened and required a shareholder vote on compensation (say on pay) and mandated that boards seek clawbacks of certain performance based compensation in the event of restatements.  Congress has begun to impose qualifications on directors, essentially requiring the presence of a financial expert.  

In preempting state law, Congress has used a variety of methods.  In the case of say on pay, the requirement was imposed on all public companies (those registered under Section 12(g) of the Exchange Act).  In the case of audit and compensation committees, Congress did so through the imposition of mandatory listing standards.

All of these areas were traditionally matters of state law.  No longer.  Which brings us to bylaws designed to limit judicial process.  Bylaws in general regulate the internal affairs of a corporation.  They can adjust the relationship between shareholders and managers.  Fee shifting bylaws, however, do not fall into this category.  First, they are not limited to cases arising out of the internal affairs of a corporation but generally apply to any action against the company or the board.  Second, they are not limited in application to shareholders but generally apply to a broader category of plaintiffs.

Yet in addressing these provisions, the Delaware Supreme Court engaged in a simplistic, management friendly analysis of Section 109.  The Section permits bylaws that are "not inconsistent with law or with the certificate of incorporation, relating to the business of the corporation, the conduct of its affairs, and its rights or powers or the rights or powers of its stockholders, directors, officers or employees".  From the Court's perspective, nothing in the language prohibited a bylaw that regulated judicial process.

As we will see in the next post, the door opened by the Delaware court is quite wide.  It has the potential to alter the rights of shareholders and investors by limiting their rights to challenge behavior in court.  We will discuss the implications of this approach and an example of the door being pushed open even wider in the next post.  

Tuesday
Nov112014

The Meaningful Return of Shareholder Access (Part 3)

The effort at private ordering instigated by the NYC Comptroller through the Board Accountability Project ought not to have been necessary. 

In 2010, the Commission adopted a rule requiring public companies to offer access to their proxy statement to 3% shareholders who held the shares for at least three-years. See Exchange Act Release No. 62764 (Aug. 25, 2010). Had that rule been left in place boards would probably already be more diverse, compensation would be less extreme, and climate change would have a higher profile in the governance process.

Nonetheless, the rule was not allowed to go into effect, having been struck down by the DC Circuit on process grounds. The court relied on a questionable interpretation of the arbitrary and capricious standard. In contrast to what is required in these sorts of cases, the court gave almost no deference to agency interpretation and adopted a view of cost-benefit analysis that exceeded the bounds of all prior interpretations. See Shareholder Access and Uneconomic Economic Analysis: Business Roundtable v. SEC.  

The weakness in the analysis used by the opinion was made abundantly clear by the recent study produced by the CFA Institute on shareholder access. See Proxy Access in the United States: Revisiting the Proposed SEC Rule. According to the Study: 

  1. Limited examples of proxy access and director nominations globally, coupled with the limited availability of corresponding market impact data, challenge whether a more detailed cost–benefit analysis was possible in the context of the court’s decision.
  2. The results of event studies suggest that proxy access has the potential to enhance board performance and raise overall U.S. market capitalization by between $3.5 billion and $140.3 billion.
  3. Assessing and measuring increased board accountability and effectiveness is challenging. None of the event studies indicate that proxy access reform will hinder board performance.

In short, there is little evidence that access was harmful and significant evidence that it benefited shareholders. Likewise, the Study suggested that there was little to be gained by an even more extensive cost-benefit analysis. 

The CFA Study likewise expands the analysis by taking the discussion out of the realm of theory and into realm of actual practice. The Study noted that shareholder access is already a fixture in countries such as the UK, Australia, and Canada. The actual experience of these countries is available to shed light on the role access plays in the governance process. The data shows modest use; according to the CFA Study:

  • We found that over the past three years, proxy access has been used only once in Canada to nominate directors to a board (where it was used successfully). In Australia, proxy access was used 11 times in the past three years, only once successfully. In the United Kingdom, proxy access was used 16 times over the past three years; it was successful on 8 occasions and was defeated 6 times, and nominees’ names were withdrawn on 2 occasions. These data suggest that proxy access is a rarely used shareowner right that is typically used only when other outlets for shareowner concerns about a company or its board—such as engagement between shareholders and companies—have been exhausted or have otherwise proved unfruitful.

Add to this data the fact that a number of companies in the United States now have access provisions in place and none have apparently been used. 

All of this suggests that access will not be particularly disruptive and will benefit companies by better focusing directors on the interests of shareholders. Given these conclusions, perhaps the time has come for an end to private ordering and a reexamination of the need for rulemaking to make access a more categorical part of the governance landscape.     

Monday
Nov102014

The Meaningful Return of Shareholder Access (Part 2)

In the aftermath of the Business Roundtable, shareholder access has largely been left to private ordering. A number of shareholder proposals have been submitted to public companies asking management to provide shareholders with access to the proxy statement.  A number have received majority support, although the numbers have been modest.    

This may change, however, with the advent of the Board Accountability Project.  Spearheaded by the NYC Comptrollers Office, the Project involves the submission of shareholder access proposals to 75 separate public companies.  The list of companies is here.  

Each of the proposals calls on companies to provide shareholders owning 3% of the voting shares for at least three years with the right to include a short slate of directors (not more than 25% of the number then serving) in the proxy statement.  The proposals largely mimics the requirements of the SEC rule struck down by the DC Circuit in Business Roundtable.   

A significant number will likely receive majority support.  This is the case for a number of reasons.  First, most will go to a vote.  These proposals are difficult to exclude from the proxy statement.  As a memo from Wachtell noted:  "The current wave of proxy access proposals has evolved to cure most substantive vulnerabilities and, absent procedural defects, the SEC has generally been unsympathetic to proxy access exclusion requests."

Whole Foods is seeking to demonstrate otherwise.  The company has sought no action relief, arguing that an access proposal (permitting shareholders owning 3% for 3 years) should be excluded because it has submitted an alternative (permitting shareholders owning 9% for five years).    

As a result, companies will likely be able to avoid a shareholder vote on an access proposal only if they prevail on the NYC Comptroller to withdraw the proposal.  That in turn will presumably require concessions by the company.  

Second, the category of companies have been carefully selected.  The companies receiving the proposals fell into three categories.  As the Comptroller's Office described, they included:

  • 33 carbon-intensive coal, oil and gas, and utility companies;
  • 24 companies with few or no women directors, and little or no apparent racial or ethnic diversity; and
  • 25 companies that received significant opposition to their 2013 advisory vote on executive compensation (“say-on-pay”)

These are not a particularly sympathetic group of companies.  Take diversity (or the lack thereof).  Given the number of qualified women and ethnic/racial minorities, it is not convincing claim to contend that a lack of diversity can be explained by an inadequate pool of candidates.  Instead, other reasons likely explain the absence of such candidates, not the least of which is the preference for directors who will reliably support management.  See The Demythification of the Board of Directors.  

Third, the Project already has significant support, particularly from other large institutional investors. According to the NYT, CALPERS has already signed on:   

  • Working with Mr. Stringer’s office to drum up support are officials at the California Employees' Retirement System, the nation’s largest public pension fund.  Calpers said it would hire a proxy solicitor to discuss the proposal with other institutional shareholders. “We view this as a five-year project and will be back again and again as needed,” said Anne Simpson, senior portfolio manager and governance director at Calpers. “But making the commitment and getting an alliance formed on this issue is so important.”

Other public pension plans "supporting the effort" include plans from Connecticut, Illinois and North Carolina.  

Fourth, these proposals have proven popular.  Last week, for example, an access proposal at Oracle received about 45% of the vote (1,578,053,610 shares in favor; 1,946,813,794 shares against).  The percentage was even more significant given that Larry Ellison held 26% of the shares and presumably voted against the proposal.  As CALSTRS (a joint sponsor of the proposal) stated: 

  • Independent shareholders overwhelmingly supported CalSTRS’ proposal opening the corporate proxy to shareholder candidate nominations for the Oracle Corporation Board of Directors. While it received approximately 45 percent of the overall vote, it did not pass due to Larry Ellison’s large inside ownership. However, CalSTRS believes shareholders today sent a strong signal to the board of directors and we expect more accountability from them, as a result.

These efforts are likely to renew interest in shareholder access.  Ultimately, however, private ordering is not the best way to approach this issue.  The proxy statement is a corporate document that ought to be available for nominees from both management and shareholders.  For that, SEC rulemaking will be necessary.   

Friday
Nov072014

The Meaningful Return of Shareholder Access (Part 1)

Directors are not chosen by shareholders.  In the case of most public companies, shareholders can only vote for a single slate of directors in something that resembles an old style Soviet election.  The decision as to who gets to serve on the board, therefore, is made not when shareholders vote but when the slate submitted to shareholders is selected.  The slate is invariably determined by the board, with input (explicit or implicit) from the CEO.  (For a discussion of this influence, see The Demythification of the Board of Directors).  The result is a system whereby directors seeking to remain on the board have greater incentive to side with management than with shareholders. 

Assorted reforms designed to ensure greater board independence and orientation towards shareholders have been tried.  The definition of director independence at the stock exchanges (but not Delaware law) has been tightened.  Listed companies must have a nominating committee that consists only of independent directors.  Nonetheless, these approaches have largely failed.  Id.  The definition of director independence does not ensure independence in fact.  Nominating committees may consist of independent directors but they can still consult with management and accept their nominees.

The one reform that did have the potential to work, however, was shareholder access.  (for a history of the SEC's efforts in this area, see The SEC, Corporate Governance, and Shareholder Access to the Board Room) as a rule by the SEC, shareholder access allowed large shareholders (or groups of shareholders) to submit a minority of directors for inclusion in the company's proxy statement.  Shareholder access made it more cost effective to run nominees not selected by incumbent management.  Access also had the potential to more closely focus directors on the interests of shareholders in order to avoid the submission of competing nominees.

The SEC's shareholder access rule was struck down by the DC Circuit on administrative grounds.  (for a discussion of the case and the weak reasoning, see Shareholder Access and Uneconomic Economic Analysis: Business Roundtable v. SEC).  The opinion was poorly reasoned and had the appearance of a result oriented decision.  Nonetheless, the decision eliminated the SEC's categorical rule on the subject. 

Since then, shareholder access has been a matter of private ordering, with shareholders submitting a modest number of proposals at specific companies calling for access.  A number received majority support.  Nonetheless, its safe to say that for the most part, shareholder access was not at the forefront of investor concerns, probably more a result of exhaustion than disinterest.

As we will discuss in the next post, that is about to change. 

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