LexisNexis Corporate & Securities Law Community 2011 Top 50 Blogs

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The Whole Foods No Action Letter and Shareholder Access

Under the title "Board Accountability Project," the New York City Comptroller has submitted shareholder access proposals to 75 corporations.  The proposals ask the board to give access rights to shareholders holding 3% of the voting shares for at least three years.   For a discussion of the Project, go here.  


A number of companies have sought to exclude the proposals and asked the SEC for a no action letter to that affect.  Some have sought exclusion under subsection (i)(9) of Rule 14a-8.  The provision permits the exclusion of a proposal that "directly conflicts with one of the company's own proposals". In a recent no action letter issued to Whole Foods, the staff granted the requested no action letter where the company indicated its intent to submit to shareholders its own access bylaw.


The only differences in the shareholder proposal and the company's bylaw were in the numerical thresholds.  Instead of the 3%/3 year thresholds in the shareholder proposals, the Whole Foods bylaw would give access rights to shareholder holding 9% of the shares for at least 5 years.  As the no action letter stated: 

  • There appears to be some basis for your view that Whole Foods Market may exclude the proposal under rule 14a-8(i)(9). You represent that matters to be voted on at the upcoming stockholders' meeting include a proposal sponsored by Whole Foods Market to amend Whole Foods Market's bylaws to allow any shareholder owning 9% or more of Whole Foods Market's common stock for five years to nominate candidates for election to the board and require Whole Foods Market to list such nominees with the board's nominees in Whole Foods Market's proxy statement. You indicate that the proposal and the proposal sponsored by Whole Foods Market directly conflict. You also indicate that inclusion of both proposals would present alternative and conflicting decisions for the stockholders and would create the potential for inconsistent and ambiguous results.  

Given the position of the staff, it is perhaps no surprise that a number of companies have already asked for similar no action relief, citing the Whole Foods letter.  For examples, go here and here.  The position of the staff in Whole Foods has, however, been appealed to the full Commission.  A discussion of the appeal and a copy can be found here.


Salvani v. ADVFN: Second Amended Complaint Dismissed for Failure to State a Claim 

Joseph M. Salvani (“Salvani”) and JFS Investments, Inc. (together “Plaintiffs”) brought suit in the United States District Court of the Southern District of New York against InvestorsHub.com, Inc., its parent company ADVFN PLC (“ADVFN”), and John Doe (collectively, the “Defendants”) for violations under Sections 10(b) and 9(a)(4) of the Securities Exchange Act of 1934 (the “Act”) and six state law claims. Salvani v. ADVFN PLC, No. 13 Civ. 7082 (ER)., 2014 BL 263638 (S.D.N.Y. Sept. 23, 2014). The court dismissed Plaintiffs’ Second Amended Complaint sua sponte pursuant to Rule 12(b)(6) for failure to state a claim upon which relief can be granted.

According to the complaint, InvestorsHub was an internet content provider, operating under the control of ADVFN, for traders and other securities professionals who posted messages seeking public review and comment. Salvani’s complaint arose out of a message defendant Doe allegedly posted on September 5, 2013, to an InvestorsHub forum entitled “CodeSmart Holdings, Inc. (ITEN),” which alleged Salvani was a “former broker barred from the financial industry” and was involved in a “pump and dump” scheme with CodeSmart to inflate securities values and profit personally.

Plaintiffs alleged Doe posted the comments with the intention of injuring Salvani and manipulating CodeSmart’s stock price; and, as a result of Doe’s comments, Salvani’s good reputation was damaged, JFS’s ability to perform under contract with CodeSmart was affected, and CodeSmart’s stock price declined. Plaintiffs claimed, shortly before Doe’s statements, CodeSmart stock “began to trade in unanticipated and unexplained volumes experiencing trading at losses and evincing signs of stock manipulation.” CodeSmart stock declined from $4.60 per share on August 30, 2013, to $1.82 per share on November 12, 2013.

Salvani made a written demand to InvestorsHub for the posts removal but InvestorsHub refused, and Salvani filed the suit under the federal securities laws. To state a private civil claim under § 10(b) of the Act and SEC Rule 10b-5, a plaintiff must plead the defendant made a material misrepresentation or omission with scienter in connection with the purchase or sale of a security, and the plaintiff relied on the misrepresentation or omission, subsequently causing economic loss. 

Defendant InvestorsHub argued Plaintiffs failed to plead reliance. Plaintiffs’ claims were not based on their own actual reliance on the false statements but on others reliance on the integrity of the market price. To rely on the integrity of the market theory, however, a plaintiff must allege that the market for shares was efficient. Because Plaintiffs did not allege CodeSmart was traded in an efficient market, they failed to properly plead reliance.

Defendant InvestorsHub also argued Plaintiffs failed to plead loss causation. Loss causation is typically shown by the reaction of the market to a corrective disclosure which reveals a prior misleading statement, or where a “concealed risk comes to light in a series of revealing events that negatively affect stock price over time.” Here, there was no corrective action taken regarding the misstatement. Plaintiffs did not identify a concealed risk that caused the value of the stock to decline when revealed; rather they alleged the false statement itself led to the decline in CodeSmart’s stock price. Because Plaintiffs did not demonstrate there was any corrective action or concealed risk that proximately caused the loss in value of CodeSmart’s stock, the court found Plaintiffs failed to properly plead loss causation.

The court dismissed Plaintiffs’ complaint pursuant to Rule 12(b)(6) for failure to state a claim upon which relief can be granted, and dismissed Plaintiffs’ claims arising under state law without prejudice. 

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


Pre-Facebook IPO Purchases and a Lifetime Bar

The SEC accepted an offer of settlement from Anthony Coronati (“Coronati”) in which he agreed to disgorge a sum of $400,000 and consented to a Cease and Desist Order pursuant to Section 8A of the Securities Act of 1933, Section 21C of the Securities Exchange Act of 1934, Sections 203(f) and 203(k) of the Investment Advisers Act of 1940, and Section 9(b) of the Investment Company Act of 1940.  See In re Anthony Coronati and Bidtoask LLC, Securities Act Release No. 9666  (Admin Proc. Oct. 17, 2014). 

According to the allegations (that were neither admitted nor denied in the settlement), Coronati, from 2008 to 2013, raised nearly $2 million from investors in various fraudulent securities offerings, misappropriating nearly $400,000 of the funds. Coronati sold investments in what the SEC described as a “fictitious . . . Fund.” He convinced investors that managers of the Fund were looking for a “30% return with minimal risk.” In other instances, he sought investors by representing that shares would increase in value as a result of an IPO. According to the Commission, Coronati “had no basis for representing that [the Fund] would soon hold an IPO or that its stock would soon be worth many times the price investors had paid.”    

Coronati also offered membership interests in Bidtoask, LLC, “falsely represent[ing] that Bidtoask would invest directly in pre-IPO Facebook shares without charging any fees, commissions, or mark-ups.” Coronati raised $1.75 million from forty-four investors, misappropriating, according to the Commission allegations, $100,000 of these investments. In addition, he invested the remaining funds in two investment funds that held Facebook shares while knowing that the “Funds charged Bidtoask fees . . . that reduced Bidtoask’s investments in the Facebook Funds to less than $1.55 million.” 

The Commission alleged other false offerings and alleged that at least some funds were used to repay investors in a Ponzi-scheme fashion. Id. (“Coronati used money he misappropriated from investors in one offering to pay back investors in another offering, in Ponzi-like fashion.”). 

In the settled case, the SEC found that Coronati and Bidtoask willfully violated Section 17(a) of the Securities Act, Section 10(b) of the Exchange Act and Rule 10b-5 thereunder, Sections 206(1), 206(2), and 206(4) of the Advisors Act and Rule 206(4)-8 thereunder. Coronati settled without admitting or denying the allegations but agreed to disgorge $292,646.36, pay $7,353.64 in prejudgment interest, $100,000 in civil penalties, and to accept a permanent bar from the securities industry.

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


Palkon v. Holmes: Motion to Dismiss Granted

In Palkon v. Holmes, 2014 BL 293980 (D.N.J. Oct. 20, 2014), the United States District Court for the District of New Jersey dismissed a derivative suit brought by Dennis Palkon (“Palkon”) against Wyndam Worldwide Corporation (“WWC”) and its board of directors (collectively, the “Defendants”) for failure to state a claim. 

According to the allegations, WWC, a Delaware corporation, operated hotels and resorts throughout the world. Between April 2008 and January 2010, hackers on three occasions stole personal customer information from WWC and its subsidiaries. The company retained technology firms to investigate the breaches and provide recommendations on enhancing the company’s security. In April 2010, the Federal Trade Commission (“FTC”) investigated the cyber-attacks, and, two years later, commenced legal action against WWC for its security practices. 

WWC received a shareholder demand to bring a lawsuit based on online breaches in November 2012. The board’s audit committee evaluated the complaint, found that it was not well grounded, and decided against bringing an action pursuant to this demand. In June 2013, Palkon sent a letter demanding that the board attend to and correct the harm inflicted on the company by the security breaches. A few months later the full board decided not to pursue legal action. 

Palkon filed a derivative lawsuit asserting that the directors failed to implement adequate data-security mechanisms (e.g., elaborate passwords and firewalls) and to disclose data breaches to shareholders in a timely manner. These failures were alleged to have resulted in significant harm to the company’s reputation and generated significant legal fees. 

To challenge a refusal of demand, a plaintiff must raise a reasonable doubt that the refusal was a business judgment by pleading that it was either “(1) made in bad faith, or (2) based on an unreasonable investigation.” The Defendants moved to dismiss Palkon’s complaint because: (1) the board’s refusal to pursue legal action was a good faith exercise of business judgment made after reasonable investigation; (2) even if the refusal was wrongful, there are no relevant claims on which to bring action; and (3) Palkon’s proposed damages were “speculative and unripe.” 

The court found that the board’s investigation was reasonable and made in good faith. The court disagreed with plaintiff’s allegations that counsel used by the board had a conflict of interest as a result of representing the company in the FTC action. The law firm “did not have multiple, conflicting duties. Instead its obligations in the FTC and shareholder matters were identical…: it had to act in WWC’s best interest.” See Id. As for the reasonableness of the investigation, the court noted that the board had “enough information” to assess plaintiff’s claim, in part as a result of the FTC action and the investigation arising from the first demand. Thus, consideration of plaintiff’s demand did not “occur in a vacuum.” See Id. “Given the business judgment rule’s strong presumption, courts uphold even cursory investigations by boards refusing shareholder demands.” 

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


Next Round in the Conflict Minerals Case Begins

The next round in the conflict minerals case has begun and will have important ramifications not only for the particular disclosures at issue in the case itself but for all compelled disclosures.  At issue in this round is the interplay of the First Amendment and compelled corporate disclosure, an issue put squarely into play in the recent American Meat decision.

On December 8th the Securities Exchange Commission filed its Supplemental Brief with the Clerk of Court for the United States Court of Appeals for the District of Columbia.  The brief was in response to a November 18, 2014 order granting rehearing of the April 14, 2014 decision of the Court of Appeals unanimously upholding many of the requirements of the conflicts mineral rule (the “Rule”) but striking down the “conflict free” labeling requirement as violative of the First Amendment.  Nat’l Ass’n of Mfrs. v. SEC, 748 F.3d 359 (D.C. Cir. 2014).   That order requested that parties submit briefs addressing the following questions: 

(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), (American Meat or AMI) have on the First Amendment issue in this case regarding the conflict minerals 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,  and

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

In its brief the SEC stated its position that the entirety of the Rule should be upheld.  The brief states: 

  • This Court’s decision in AMI makes clear that the conflict minerals disclosure is consistent with the First Amendment under either Zauderer or Central Hudson. The en banc court held that Zauderer applies to commercial disclosures of “purely factual and uncontroversial information about the good or service being offered” so long as they are supported by any sufficient governmental interest. And Zauderer and its progeny make clear that information is “factual and uncontroversial” if it provides objectively determinable facts and the disclosure is not tantamount to a statement of viewpoint, belief, or ideology. The description of products that “have not been found” to meet the statutory definition of “DRC conflict free,” made in the context of a detailed description of the issuer’s efforts to trace the origin of the minerals in its products, meets these criteria.  Zauderer therefore applies, and the conflict minerals disclosure survives such scrutiny.

A disclosure is factual and uncontroversial if it provides objectively determinable facts and is not tantamount to a statement of viewpoint, belief, or ideology; whether a disclosure meets this standard is a mixed question of law and fact. 

With regard to the controversial or uncontroversial nature of the disclosure required by the Rule, the SEC faces a tough battle.  The court in NAM made the strong statement (although it was not a ruling) that relaxing the level of scrutiny given to compelled commercial speech too much would give too much deference to regulating authorities in contravention of the First Amendment.  Such a relaxed standard “would allow Congress to easily regulate otherwise protected speech using the guise of securities laws. Why, for example, could Congress not require issuers to disclose the labor conditions of their factories abroad or the political ideologies of their board members, as part of their annual reports? Those examples, obviously repugnant to the First Amendment, should not face relaxed review just because Congress used the "securities" label.” 

In response, the SEC argued that NAMs contention that the ….term “DRC conflict free” [is controversial] because it carries the “unmistakable connotation” that the issuer is “immoral and has not done enough to avoid responsibility for the conflict” is simply wrong.  The SEC argues that the connotation will be negated “because the extent of the issuer’s efforts is conveyed in the disclosure itself.”  Further, “the Supreme Court has made clear that the remedy for the hypothetical stigma appellants fear is not to suppress the information provided in the disclosure,  but rather to allow more speech (as the rule does).” If issuers worry that the disclosure requirement will confuse investors as to the issuers’ position on the conflict minerals issuer, the Rule permits “the disclosure of any additional information the issuer wishes to provide to dispel any perceived confusion about its connection to the conflict.”

As to whether the Rule passes Zauderer review the SEC states:

  • The first step in applying Zauderer is to “assess the adequacy of the interest motivating the [statutory] scheme.” AMI, 760 F.3d at 23. Because the governmental interest asserted in AMI was “substantial,” the Court did not decide whether a lesser interest would suffice. So too here: appellants “do not contest that the government’s interest in promoting peace and security in the DRC is substantial, even compelling.” Opening Br. at 54. “[W]hat remains,” then, “is to assess the relationship between the government’s identified means and its chosen ends.”

Here, the conflict minerals disclosure is “reasonably crafted” (id. at 26) to provide information about an issuer’s products without chilling protected speech. The rule is not a labelling requirement. Nor does it require that the challenged statement be made in the context of an issuer’s advertising. And issuers are not required to separately or conspicuously publish a list of products that have not been found to be “DRC conflict free.” Rather, the challenged statement is required once a year in the body of a conflict minerals report filed with the Commission and posted on an issuer’s website, at a location of its choosing. The disclosure is thus not “temporally, tangibly, or otherwise linked to other fully protected speech.”

The SEC brief further argues that even if the lesser Zauderer review standard is not applied to the Rule, that it still passes constitutional muster because it satisfies the more stringent Central Hudson review because it is “narrowly tailored” and is a ‘reasonable fit’ or a ‘reasonable proportion’ between means and ends.”

While the SEC brief naturally makes no mention of it, the position of the Commission in regard to the Rule is less than unified.    According the Bloomberg news, on the same day the brief was filed, SEC Commissioners Daniel Gallagher and Michael Piwowar issued a joint statement stating their opposition to the position taken in the SEC's brief.

“Requiring persons to presume their guilt by association with the current tragedy in the Congo region unless proven otherwise is neither factual nor uncontroversial….”  “Other alternatives might effectively convey the message as to which products contain conflict minerals without this assumption.”

The commissioners urged the court to remand the matter to the SEC for further consideration and “suspend the effectiveness of the rule pending completion of such proceedings.” 

The D.C. Circuit panel has called for an expedited briefing schedule, and the business groups challenging the SEC rule—the National Association of Manufacturers, the U.S. Chamber of Commerce and the Business Roundtable—have 20 days from the filing of the SEC's brief to file their brief.


Fee Shifting Bylaws and the Challenge to the Internal Affairs Doctrine

Fee shifting bylaws were effectively authorized by the Delaware Supreme Court's decision in ATP.  The opinion was excessively broad and not well reasoned.  In many ways, however, it followed from the Chancery Court's decision in Chevron on forum selection bylaws.  The latter case suggested that Section 109 of the Delaware Code imposed no real facial limits on bylaws that affected the judicial process.  ATP was a short step from that reasoning.

Yet the decision has already had a number of unintended consequences, some of which may do long term damage to the preeminent position of Delaware in the development of corporate law.  While the ATP court did not use the phrase "internal affairs," it is likely that the court saw the matter as arising from that doctrine. As a result, the validity of a fee shifting bylaw adopted by a Delaware corporation would be determined by Delaware, whether the courts or the legislature.

Yet the statute adopted in Oklahoma emphatically rejected that approach. The state decided to make fee shifting mandatory in derivative suits.  Perhaps more importantly, the state applied the interpretation to actions filed by a "domestic or foreign corporation."  In other words, the legislature has no intention of allowing the state of incorporation to determine rules of the game with respect to fee shifting in derivative actions, at least when the claim was filed in Oklahoma.

To the extent that fee shifting is not, in fact, a matter of internal affairs, then states can, individually, determine the applicable approach for actions filed in their jurisdiction.  Other states could do what Oklahoma did and make application of fee shifting mandatory.  States could also, however, take the opposite approach. They could, by statute, provide that fee shifting bylaws or articles are invalid for any derivative action filed within the state, whether by foreign or domestic corporations.

The Cornerstone data shows that, after Delaware, shareholder suits brought in merger cases are most commonly filed in New York and California.  (The Cornerstone data is here).  To the extent that either of these states invalidated fee shifting provisions, shareholders would have a considerable incentive to make them the forum of choice.  The number of actions filed (on behalf of resident shareholders) would presumably skyrocket (and the number in Delaware plummet).

Such a prohibition would also provide a ready basis for the non-enforcement of forum selection bylaws. To the extent that companies had such bylaws in place, a court in NY or California (or any other jurisdiction that invalidated fee shifting bylaws) could easily view enforcement of a forum selection provision as unreasonable or inequitable where shareholders would be, as a result, subjected to the risk of fee shifting.  

The issue is whether states like NY or CA would have an incentive to adopt this type of provision.  In effect, the states would be inviting additional litigation, adding to the burden of the courts in the state.  Perhaps the parties could be assessed fees to pay these costs.  Moreover, as Delaware had learned, corporate litigation fills the hotels and restaurants, increasing economic activity and tax revenues.

In any event, the ATP decision has resurrected concern with the internal affairs doctrine, an issue that hasn't been front and center since the litigation over Section 2115 of the California Corporate Code.  Moreover, it has the capacity to impact Delaware hegemony in the corporate law area.  ATP, therefore, may be a management friendly decision but it may ultimately prove to be very unfriendly to Delaware.    


Fee Shifting Bylaws and the "Supporting" Rational (Part 2)

What about the rational of the Chamber for opposing fee shifting bylaws?  Lets focus on the rational provided in a recent WSJ editorial written by the head of the Chamber's Institute for Legal Reform.  

Here again the concern is not expressed as an interested in insulating directors from bad behavior but from cutting off excessive litigation.  

In this editorial, the excessive litigation concern arose out of the number of suits filed in connection with mergers and acquisitions.  According to the editorial, suits have been filed in "90% of all corporate mergers and acquisitions valued at $100 million since 2010."  The litigation was described as efforts by "small, pirate-like investors" having the goal of forcing "a big settlement by holding the deal hostage."  

The approach has a number of problems.  First, fee shifting bylaws are not limited to merger cases but apply to any action brought against corporations or directors.  The editorial makes no effort to assess the impact on these actions.  

Second, the editorial uses pejorative labels in place of analysis.  The analysis makes it sound like all actions brought in the merger area are designed to hold deals hostage.  Yet these suits do no such thing.  Courts do not let them interfere with closings.  Relief before the closing is routinely denied, forcing the matter to be litigated after the merger has closed.  According to Cornerstone, 25% of the cases are not resolved until after the transaction has closed.  

Moreover, the commonality of suits provides absolutely no data on the costs and benefits of the actions.  Thus, the article makes no mention of the "pirate" firms that obtained, according to Cornerstone, a settlement of $200 against Kinder Morgan in 2010, $89.4 against Del Monte in 2011, and $110 against El Paso in 2012.  In 2014, the Chancery Court awarded damages in Rural of $75 million and a settlement was recently announced in connection with Activision for $275 million.  

Plaintiffs able to obtain these sorts of settlements or judgments presumably had a stronger case on the merits. Yet given the management friendly nature of the courts in Delaware, many of these actions would presumably not have been filed had they been subject to a fee shifting bylaw.  The Editorial makes no effort to assess the overall benefit of these suits or the impact of fee shifting bylaws on meritorious cases.  

Perhaps most surprisingly, the Editorial apparently viewed fee shifting bylaws as necessary to reduce the exercise of appraisal rights.  Appraisal rights aren't mentioned by name but, according to the Editorial, there are "a small yet sophisticated investor group" who sue "to force higher revaluations of their and any other objectors’ holdings."  In these circumstances, the company must either pay them a premium or "fight them and pay as much as 10% or more interest as required under current Delaware law, if they convince a judge their shares should be worth a few cents more."

The reference to "objectors" and interest suggest that the Editorial is referring to appraisal actions.  Appraisal actions allows shareholders unhappy with the merger price to petition a court and have a court determine the fair value of the shares.  The Editorial apparently views the exercise of this right as a an abuse.  It ignores the fact that shareholders doing so take significant risk (they can receive a value less than what was paid in the merger) and can be made to pay the company's costs if filing an action in bad faith.  

Moreover, the existence of appraisal rights provides acquirers with an incentive to pay shareholders of the target a price that will minimize the risk that they will petition a court for a determination of fair value. Eliminating the right to bring an appraisal action through fee shifting bylaws will provide an incentive on the part of acquirers to offer lower the price paid to shareholders.  

In the end, fee shifting bylaws may allow for lower payments to shareholders in mergers and will shield bad at least some behavior from challenge.  These are significant costs.  The benefits that outweigh these costs cannot be found in this Editorial.   


Fee Shifting Bylaws and the "Supporting" Rational (Part 1)

Fee shifting bylaws have their supporters. Certainly those who benefit from them are supportive. They will reduce the number of law suits against directors and corporations. The Chamber supports this, having opposed the efforts by the Delaware legislature to do away with the bylaws. So does Steve Bainbridge.

No one gives as a reason the need to insulate directors from liability for their bad acts. Instead, proponents of the bylaws argue that they are necessary to prevent frivolous or excessive litigation. Steve's post is titled "The case for allowing fee shifting bylaws as a privately ordered solution to the shareholder litigation epidemic." So bylaws are a solution to the "litigation epidemic."  

His post mostly focuses on litigation under the federal securities laws. His argument that securities cases are filed in excessive numbers is weak. He notes a number of studies from 2006 to 2007 that suggest the amount of securities litigation is excessive. These studies were always open to question. The idea that the decline in foreign listings on the stock exchanges could be explained by the fear of litigation risk (rather, say, than the increased quality of the exchange in the home market), was always questionable. But in any event the studies are based on data that is no longer accurate.

Thus, Steve notes the following: "Between 1997 and 2005 there was a steady increase in both the number of securities class action filings and the average settlement value of those suits." During the selected period, approximately 250 securities class action suits were filed each year--an average increased by the 498 actions filed in 2001 as a result of the raft of IPO allocation cases (The data is on the Stanford Securities Class Action Site). But an examination of the data since 2005? The nine year average from 2006 through Dec. 14, 2014 is 166, with 2014 on course to have the second lowest number of securities class action laws suits (144) since 1996.  

The numbers have likely come down because of the PSLRA (cases being dismissed for failing to demonstrate a "strong inference" of scienter) and the Supreme Court (Janus, for example). His analysis, therefore, does not take into account recent data, does not establish that there is a litigation epidemic, and certainly doesn't explain how the market will benefit from reducing the number of class actions below 144. Indeed, he concedes the "obvious benefits" of an "effective anti-fraud regime."    


Fee Shifting Bylaws and the Reaction of Institutional Investors (Part 4)

We are discussing letters written by a number of institutional investors to proxy advisory firms and policymakers in Delaware. Copies of the letters can be found here.

Will these letters have any influence?

They certainly provide evidence that shareholders do not favor fee shifting bylaws. They make more difficult (although not impossible) the argument that fee shifting bylaws are really intended to benefit shareholders rather than management. They also raise the profile of fee shifting bylaws, indicating that the matter goes well beyond the interests of the plaintiffs' bar.  

The issue will likely return to the state legislature sometime in 2015. In 2014, the legislature had before it an effort to resolve the issue. A Senate Bill would have provided that "neither the certificate of incorporation nor the bylaws of any corporation may impose monetary liability, or responsibility for any debts of the corporation, on any stockholder of the corporation, except to the extent permitted by Sections 102(b)(6) and 202 of this title."  

Justice Ridgely, in his recent article on bylaws, had this to say: 

  • A majority of the Delaware State Bar Association’s Council of the Corporation Law Section had a similar concern and earlier this year proposed an amendment to the DGCL through Senate Bill 236, which would prohibit fee-shifting bylaws from a stock corporation’s governing documents. The proposed legislation garnered substantial attention and prompted a significant amount of lobbying efforts for and against the bill. In June 2014, the Senate Bill was tabled in favor of a resolution giving representatives of the Delaware bar more time to study the use and effect of fee-shifting bylaws. Although tabled for now, the proposed legislation has put entities and investors alike on notice that an amendment to the DGCL will likely be considered again when the legislative session resumes in 2015.

The views of institutional investors provide a counterweight to those earlier "lobbying efforts" and presumably provide additional incentive for the Delaware legislature to act. 


Fee Shifting Bylaws and the Reaction of Institutional Investors (Part 3)

We are discussing letters written by a number of institutional investors to proxy advisory firms and policymakers in Delaware. Copies of the letters can be found here.

More than influence state law, the letters from investors sought to increase the consequences of fee shifting bylaws in the proxy process. Letters were written to ISS and Glass Lewis noting a number of concerns. These included an absence of any meaningful limits on the breadth of fee shifting bylaws. See Id. ("In fact, if a unilaterally adopted bylaw can be used to target stockholder litigants, then there may be no distinction to prevent boards from using bylaws to impose fee shifting against stockholders who merely pursue proxy solicitations against the board.").

In addition, fee shifting bylaws provided a financial penalty even for some meritorious cases. Id. ("Allowing corporate directors to require stockholders to bear the expenses a corporation may incur in fighting stockholder litigation, even if the suit has merit, effectively eliminates the ability of stockholders to look to Delaware courts to protect their rights as the owners of corporations.").  

The letters recommended that the proxy solicitation firms formulate an explicit policy addressing these bylaws. 

  • We believe that it would be appropriate for ISS to adopt a policy recommending that shareholders vote against the reelection of any director who uses bylaw amendments as a weapon to eliminate stockholder rights. We believe such a policy would serve as a strong deterrent to discourage corporate boards from using bylaw amendments to remove accountability over directors render their fiduciary obligations illusory.

A larger role for ISS and Glass Lewis could have broad impact. Directors are, for the most part, elected under the plurality system. Unless shareholders run a competing slate of directors, the management nominated candidates always win. As a result, increasing the number of negative votes will not prevent reelection.  

Most large companies have in place a majority vote policy. These policies typically require that directors who fail to receive a majority submit a letter of resignation. Since boards are for the most part unlikely to accept these resignations, shareholders will not be able to defeat directors even at companies with majority vote provisions.

Nonetheless, a policy encouraging "no" votes with respect to directors who "uses bylaw amendments as a weapon to eliminate shareholder rights" would, at a minimum, be uncomfortable for the board, potentially impair communications with shareholders, and alienate long term shareholders. Companies have an incentive to avoid this result.  

Moreover, the approach has worked in the past. When activist shareholders proposed paying their nominees additional compensation based upon performance, some companies adopted bylaws designed to prohibit the practice. In 2013, ISS recommended that shareholders vote against three directors that approved a bylaw restricting director payment from anyone other than the company. The directors were elected "by an unusually low margin."

The risk of a "just say no" campaign and shareholder opposition to director candidates, therefore, provides boards with at least some disincentive to adopt fee shifting bylaws.  


Fee Shifting Bylaws and the Reaction of Institutional Investors (Part 2)

We are discussing letters written by a number of institutional investors to proxy advisory firms and policymakers in Delaware. Copies of the letters can be found here.

With respect to Delaware policymakers, the letters sought to raise concerns over those arguing that the bylaws benefited investors.   

  • While lobbyists hired by corporate interests are trying to portray these bylaws as protecting shareholders, the exact opposite is true. These bylaws effectively make corporate directors and officers unaccountable for serious wrongdoing. The General Assembly must act promptly to restore confidence in Delaware’s credibility in developing a balanced corporate law, preserve stockholders’ access to the court system, and make clear that directors and officers cannot insulate themselves from accountability under the guise of unilateral bylaw or charter provisions.

Investors could speak for investors.  Id.  ("We must make clear that these lobbyists do not speak for the interests of the nation’s public investors.").  

And, in fact, the investors sending in the letters opposed the bylaws.   

  • Far from protecting corporations from “frivolous litigation,” these fee-shifting provisions effectively bar any judicial oversight of misconduct of corporate directors. They undermine the most fundamental premise of the corporate form – that stockholders, simply by virtue of their investment, cannot be responsible for corporate debts.

Investors objected because the bylaws "essentially remove[d] judicial oversight over corporate wrongdoing by effectively foreclosing stockholders' access to courts" by preventing "meritorious stockholder claims" and "render[ing] illusory the fiduciary obligations of corporate directors."  As the letters asserted: 

  • such provisions bar all judicial oversight by making it economically unfeasible for stockholders to seek redress in Delaware courts to protect their rights. Without adequate protections and reasonable access to the courts to hold corporate fiduciaries accountable when they violate their obligations to stockholders, investor confidence diminishes and market participation suffers, hurting investors and the businesses in which they invest. 

The letters posed a number of consequences likely to result from the continued use of the bylaws.  Investment in Delaware corporations could decline.  Id. ("Allowing directors to impose personal liability on stockholders through bylaw amendments would make continued investment in Delaware corporations untenable."). Mostly, though, the letters posed a theat to Delaware.   

Their use could "directly and materially impair the Delaware economy."  Likewise, they threatened the preeminent role of Delaware with respect to the development of corporate law.   

  • Delaware has a substantial interest in the development of its corporate law, and the inevitable widespread adoption of fee-shifting bylaws will impair the development of that law. For more than one hundred years, the Delaware judiciary has provided a fair forum for the resolution of intra-corporate disputes. The Delaware Court of Chancery is generally considered the nation’s “pre-eminent” business court, and virtually every state in the country looks to Delaware law in the development of its own corporate law. If Delaware corporations adopt fee-shifting bylaws, however, the Delaware judiciary will be relegated to the sidelines and a major justification for investing in Delaware corporations will disappear.

The letters raise shareholder concerns with respect to these bylaws.  They make it far more difficult for proponents of the bylaws to assert that they are beneficial to shareholders.  


Fee Shifting Bylaws and the Reaction of Institutional Investors (Part 1)

Whats the latest in the controversy over fee shifting bylaws?

Since the Delaware's approval of the bylaws in ATP, the number of companies adopting them have proliferated. Most have adopted them as bylaws.  Some,  however, have inserted them in their articles, something that can be done just before going public or when seeking shareholder approval of a reorganization.  

The Delaware courts have not definitively ruled on the validity of these bylaws in the context of for profit companies.  The Delaware legislature has tabled but not definitively determined whether to act with respect to these bylaws.  Other possible responses may come from the states (see Oklahoma), from the SEC, or, eventually, from Congress.  For now, however, the Delaware legislature and private ordering are the most immediate areas where, in the short term, some type of response is possible. 

In that regard, the issue has begun to attract the attention of investors.  A group of institutional investors wrote letters to policy makers in Delaware and proxy advisory firms in connection with fee shifting bylaws.  They included letters to Governor Markell and Norman M. Monhait, Chair of the Delaware Bar Association's Section of Corporation Law and  Bryan Townsend, Legislative Hall Office, and letters to Robert McCormick, Chief Policy Officer, Glass, Lewis & Company, LLC Martha Carter, Global Head of Research Institutional Shareholder Services, Inc.  

Institutions signing onto the letters are a wide cross ection that includes APG Asset Management NV, California Public Employees’ Retirement System, Colorado Public Employees’ Retirement Association, Office of Connecticut State Treasurer’s Office, Florida State Board of Administration, Houston Municipal Employees Pension System, Pension Reserve Investment Management Board Commonwealth of Massachusetts, Middlesex County Retirement Board, MN Services, The New York City Employees’ Retirement System, The New York City Police Pension Fund, The Board of Education Retirement System of the City of New York * The Teachers’ Retirement System of the City of New York, The New York City Fire Department Pension Fund, The Teachers’ Retirement Systems’ Variable A, North Carolina Department of State Treasurer, Oregon State Treasurer’s Office, PGGM Investments, and San Diego City Employees' Retirement System.

We will discuss these letters in the next few posts.  Copies of the letters can be found here.


SEC v. Braverman: Declarations in Support of SEC’s Emergency Application for an Asset Freeze and Other Relief

We are following SEC v. Braverman, No. 1:14-cv-07482 (S.D.N.Y. Sept 16, 2014).

On September 16, 2014 the SEC alleged Braverman engaged in unlawful insider trading and sought disgorgement of Braverman’s illegally acquired gains. After filing its complaint, the SEC promptly filed an emergency application to freeze all assets associated with Braverman (the “Application”), including assets controlled by Braverman and assets Braverman allegedly transferred abroad to and through relief defendant, Vitaly Pupynin (“Pupynin”). This post examines separate, but concurrent declarations filed on September 17, 2014 by Jordan Bakerand Charu A. Chandrasekhar in support of the SEC’s Application. 

Jordan Baker, a securities compliance examiner for the SEC, supported the Application based on personal knowledge obtained through an investigation of the case. Pursuant to 28 U.S.C. § 1746, Baker declared the following: (1) Braverman signed an agreement to be bound by the confidentiality and insider trading policies of his employer, Wilson Sonsini Goodrich & Rosati, Professional Corporation (“Wilson Sonsini”); (2) Wilson Sonsini represented eight companies in eight separate merger and acquisition transactions, producing documents to which Braverman had access; (3) trade records for brokerage accounts held by Braverman, Pupynin, and Braverman’s brother revealed profits associated with the trading of these companies in the amount of $304,837.39; and (4) phone records revealed calls between Braverman and his brother on relevant dates.

With regard to Pupynin, Baker declared the following: (1) between October 2013 and August 2014 transfers of over $25,000 were made to accounts held by Pupynin, and a transfer of $26,000 was made to a Latvian account through an account under Pupynin’s name, but associated with Braverman’s email; (2) flight records reveal Pupynin was not in the United States at times relevant to the transactions; (3) Braverman and his wife were subscribers to IP addresses from which the Pupynin account was accessed preceding such transactions; and (4) the IP address used to access the Pupynin account matched the IP address used to access Braverman’s other brokerage accounts.

Charu A. Chandrasekhar, a Senior Attorney at the SEC’s New York Regional Office, supported the Application based on personal knowledge of Braverman’s illegal trading and Baker’s declaration. Chandrasekhar declared the Application essential to the effective adjudication and relief associated with the complaint. A notice by motion, he asserted, would trigger Braverman’s deliberate transfer of illegally gained assets outside the reach of the court and the SEC. In support of this assertion, Chandrasekhar proffered three reasons for the Application: (1) to maintain the status quo until judgment on the Application; (2) to protect future judgment ordering disgorgement; and (3) to avert the corruption of evidence. 

The primary materials for this post can be found at the DU Corporate Governance website under the subsequent citations:  

Local Rule 6.1 Decl. of Charu A. Chandrasekhar in Support of Pl’s. Emergency Appl. For an Asset Freeze and Other Relief, SEC v. Braverman, No. 1:14-cv-07482 (S.D.N.Y. Sept. 17 2014).

Decl. of Jordan Baker in Support of Pl. SEC’s Emergency Appl. For an Asset Freeze and Other Relief, SEC v. Braverman, No. 1:14-cv-07482 (S.D.N.Y. Sept. 17 2014). 


Guns, Ordinary Business, and Shareholder Proposals: Reordering the Priorities of the SEC Staff (Part 5)

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

The case has significant potential implications.    

First, the case demonstrates that there is a practical method of seeking review of staff decisions other than appealing them to the Commission.  Moreover, the court gave no real deference to the views of the staff. See Trinity v. Wal-Mart ("It is undisputed that the final determination as to the applicability of the ordinary business exception is for the Court alone to make.").  Resort to the judiciary does involve delay and expense but ultimately Trinity got the relief that it wanted, albeit one year later.    

Second, the case provides a precedent that can be used by shareholders to narrow the staff's interpretation of "ordinary business."  The proposal was crafted to focus on governance rather than actual product sales. All significant decisions affecting the business were left to the board, the place where they legally belong.  The court found that this approach did not implicate the company's "ordinary business."    

Third, the case involves judicial consideration of the public policy exception. The court had no trouble finding that the standard was met by a proposal relating to "the social and community effects of sales of high capacity firearms at the world's largest retailer and the impact this could have on Wal-Mart's reputation, particularly if such a product sold at Wal-Mart is misused and people are injured or killed as a result."  

Fourth, the case returned a degrree of balance to the interpretation of the ordinary business exclusion. Much the way Judge Tamm did in Medical Committee for Human Rights v. SEC, the court noted the negative implications of an excessively broad interpretation of the "ordinary business" exclusion.  

  • It is true that the ordinary business exception of Rule 14a-8(i)(7) is written broadly, allowing exclusion of a shareholder proposal that "deals with a matter relating to the company's business operations." 17 C.F.R. § 240.14a-8(i)(7) (emphasis added); see also D.I. 51at5. However, viewed at a general level, anything a company like Wal-Mart does at least somewhat "deals with" a matter "relating to" the company's business operations. Such a broad reading is inconsistent with the guidance provided by the SEC itself (for reasons already explained above) and, if adopted, would improperly permit the "exception to swallow the rule."

The case remains an isolated decision.  An appeal is possible.  Nonetheless, the decision raises the specter of greater judicial involvement in the shareholder proposal process and the development of standards that will ultimately impact the review process by the staff.    

For a more detailed discussion of the "ordinary business" exclusion and the public policy exception, see Essay: The Politicization of Corporate Governance: Bureaucratic Discretion, the SEC, and Shareholder Ratification of Auditors

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.


Guns, Ordinary Business, and Shareholder Proposals: Reordering the Priorities of the SEC Staff (Part 4)

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

Trinity did not simply accept the decision of the staff in allowing Wal-Mart to exclude its proposal. Trinity sought to enjoin Wal-Mart from excluding the proposal from the 2014 proxy materials, essentially asking the court to overturn the determination of the SEC's staff.  

The trial judge initially declined to grant a preliminary injunction and viewed the time as inadequate to render a decision on the merits. See Trinity v. Wal-Mart ("The Court could not have resolved the merits of the parties' dispute before Wal-Mart planned to print its proxy materials for the 2014 annual meeting.").

The court, however, eventually resolved the matter and ultimately disagreed with the staff's view on the proposal. From the court's perspective, the matter did not involve the company's ordinary business: 

  • Trinity's 2014 Proposal is best viewed as dealing with matters that are not related to Wal-Mart's ordinary business operations. Therefore, Trinity's Proposal was not properly excluded from Wal-Mart's 2014 proxy materials under the ordinary business exception of Rule 14a-8(i)(7).

The proposal did not dictate the products that would or would not be sold.  Instead, that matter was left to the board:

  • At its core, Trinity's Proposal seeks to have Wal-Mart's Board oversee the development and effectuation of a Wal-Mart policy. While such a policy, if formulated and implemented, could (and almost certainly would) shape what products are sold by Wal-Mart, the Proposal does not itself have this consequence. As Trinity acknowledges, the outcome of the Board's deliberations regarding dangerous products is beyond the scope of the Proposal. Any direct impact of adoption of Trinity's Proposal would be felt at the Board level; it would then be for the Board to determine what, if any, policy should be formulated and implemented.

The court also found that, even if arguably involving ordinary business, the public policy exception applied: 

  • Moreover, to the extent the Proposal "relat[es] to such matters" as which products WalMart may sell, the Proposal nonetheless ''focus[es] on sufficiently significant social policy issues" as to not be excludable, because the Proposal "transcend[s] the day-to-day business matters and raise[s] policy issues so significant that it would be appropriate for a shareholder vote." The significant social policy issues on which the Proposal focuses include the social and community effects of sales of high capacity firearms at the world's largest retailer and the impact this could have on Wal-Mart's reputation, particularly if such a product sold at Wal-Mart is misused and people are injured or killed as a result. In this way, the Proposal implicates significant policy issues that are appropriate for a shareholder vote. Additionally, again consistent with the 1998 Release, the Proposal is not excludable because it does not seek to "micro-manage" Wal-Mart or "prob[e] too deeply into matters of a complex nature upon which shareholders, as a group, would not be in a position to make an informed judgment." The Proposal does not involve "intricate detail" or seek to "impose specific time-frames" or dictate a "method[] for implementing complex policies."

The court granted Trinity's motion for summary judgment and also granted injunctive relief prohibiting Wal-Mart from relying on the "ordinary business" exclusion with respect to the proposal in the 2015 proxy materials. We will discuss the implications of the case in the next post.   

The decision is posted at the DU Corporate Governance web site. 


Guns, Ordinary Business, and Shareholder Proposals: Reordering the Priorities of the SEC Staff (Part 3)

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

Wal-Mart sought exclusion of the proposal arguing that it involved the company's ordinary business. The proposal met this standard, according to the company, because it implicated "decisions by retailers as to products they sell."

The letter from the company also addressed the public policy exception. The letter conceded that the staff had, in the past, "found some proposals addressing the issue of gun violence to implicate significant policy issues." In asserting the inapplicability in this case, the company argued not that the subject matter was unimportant but that the proposal was either too broad or too narrow.      

As the letter reasoned, proposals addressing matters of public importance could still be "overly broad in nature." In this case, the company asserted that "[t]he broad language of the Proposal and supporting statement implicates many products beyond firearms, especially in light of the multitude of products the Company offers."    

At the same time, however, the company argued that the proposal was too narrow. The letter asserted that the company was "not a manufacturer of the firearms and related products that the Proposal references." As a result, there was not a "sufficient nexus" between the nature of the proposal and the company. "Here, to the extent the Proposal addresses decisions relating to the Company’s sale of firearms with 'high capacity magazines,' the subject matter of the Proposal directly relates to the Company’s ordinary business operations as a retailer and not a manufacturer of firearms and related products." 

Trinity predictably disagreed with the analysis. It argued the issue did not even implicate the "ordinary business" of the company:

  • The Proposal seeks neither to supplant management's day-to-day decision-making nor to micro-manage the Company. Instead, the Proposal focuses on corporate governance by requesting that the charter of a Board committee include a mandate to supervise the formulation and implementation, and public reporting of the formulation and implementation, of the interplay between the Company's general policies and standards that determine whether or not the Company should sell a product and the strategic considerations of endangering public safety and well-being, and the related risks of significant harm to the Company's reputation and brand. Implementation of the Proposal would not constitute meddling in ordinary course decision-making. It requests engagement on broad strategic considerations at the Board level.  

Trinity also asserted that it was not trying to dictate the products that could and could not be sold by the company:  

  • The Proposal does not seek to determine what products should or should not be sold by the Company. The objectives of the Proposal would be satisfied if the Board were to adopt a provision in a committee charter to ensure that there is proper consideration and oversight of policies governing whether to sell products that pose a high risk of harming public safety and well-being or damaging the Company's reputation or brand. This corporate governance concern--and not the sale or prohibition of any particular product--is the focus of the Proposal. In short, far from impinging on management's prerogative to oversee day-to-day decision-making, the Proposal recognizes and supports the allocation of such decisions to management with appropriate Board oversight.   

As for the argument that the public policy exception was inapplicable, Trinity described the position as "a tidy Catch-22." On the one hand, the "Proposal is so narrow as to micro-manage the decisions of the products to be offered by the Company" but on the other hand "too broad to address any articulable policy issue." As Trinity reasoned: "The social policy issue of whether and under what standards a company should take account of especially high risks of harm to the community in making merchandizing decisions is no less important than the environmental and animal testing concerns that have been found to be worthy of Board consideration at the request of shareholders."  

The staff of the SEC ultimately sided with Wal-Mart. It had this to say: 

  • There appears to be some basis for your view that Walmart may exclude the proposal under rule 14a-8(i)(7), as relating to Walmart's ordinary business operations. In this regard, we note that the proposal relates to the products and services offered for sale by the company. Proposals concerning the sale of particular products and services are generally excludable under rule 14a-8(i)(7). Accordingly, we will not recommend enforcement action to the Commission if Walmart omits the proposal from its proxy materials in reliance on rule 14a-8(i)(7).  

The reference to goods and services was little more than a restatement that the proposal implicated the company's ordinary business. Trinity's argument that the proposal was really about governance was presumably rejected. But in finding the proposal involved ordinary business, the staff failed to explain the inapplicability of the public policy exception. 

Ordinarily this would be the end of the story. Staff decisions can be appealed to the Commission but review is rarely granted. As a result, a decision to allow for the exclusion of a proposal and the staff's reasoning is generally not subject to examination by a neutral decision maker. In this case, however, Trinity sought review in the courts. We will discuss the court's opinion 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.


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.


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.  


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.


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

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