Preliminary Voting Data and the Need for A Clear Federal Approach: Red Oak Fund, LP v. Digirad (Part 6)
We are discussing Red Oak v. Digirad, a Delaware case analyzing claims that arise out of the use of preliminary voting data.
So where does this leave things?
First, Digirad and Red Oak were both soliciting proxies. As a result, Broadrdige provided both with the same preliminary information. In theory this left them on an equal footing.
The distribution of the information does not arise under state law. Under federal law, there is no explicit requirement to distribute preliminary information to participants in a contest. Moreover, Broadridge distributes and collects voting instructions on behalf of brokers. Therefore, to the extent that there are contractual provisions that address distribution of preliminary data, they are between Broadridge and the broker. Nonetheless, whatever the source, distribution of preliminary voting data to anyone soliciting proxies appears to be the standard practice.
Second, under state law, management with preliminary voting data can, apparently, make statements to individual investors that are arguably inconsistent with the data without significant concern. Some of the lack of concern arises over the difficulty in detection. Shareholders challenging the practice will have to uncover statements made by management to other investors (or their advisers). This will often be extremely difficult.
In addition, it is clear that the courts are likely to treat the information, even if detected, as speculative and immaterial. In arriving at this determination, the court effectively applied a materiality standard that is inconsistent with the test articulated. This is not the first time that this has occurred. Delaware courts use the federal definition of materiality (important to a reasonable shareholder) but impose a significantly higher burden on shareholders. See The Irrelevance of State Corporate Law in the Governance of Public Companies. This was the case here. Rather than show that the alleged misstatements were important to a reasonable investor, the court effectively required a showing that the information actually caused a shareholder to change its votes, an all but impossible standard to meet.
Third, under state law, apparently, companies can cause mistakes in the preliminary voting tallies that are distributed to others by Broadridge, know about the mistakes, benefit from the mistakes, and still escape any concern that the court will find an unfair election. Unless the court finds bad faith or intentional misbehavior, there is no recourse for disadvantaged investors. Moreover, the track record of the Delaware courts suggests that they will almost never find that shareholders have met this burden.
The case, therefore, raises the potential for abuse of preliminary voting data and suggests that state law will not intervene to prevent any such abuse. Assurances that the information is used fairly will, therefore, have to be imposed at the federal level. Possibilities might include, among other things: mandatory disclosure of preliminary voting information to the public (by Broadridge or any recipient); prohibitions on disclosure of the information by Broadridge to anyone, a mechanism designed to facilitate the correction of preliminary tallies when errors are uncovered; and/or the execution of an omnibus proxy by the broker on behalf of street name owners, eliminating the need for voting instructions.
Any such approach has its own set of problems. The best solution would have been to require companies to use the information in a manner that was fair to shareholders. Red Oak, however, demonstrates that the Delaware courts have no intention of taking this route.
The opinion and assorted filings in the case, including the transcript of the hearing, can be found at the DU Corporate Governance web site.