Preliminary Voting Data and the Need for A Clear Federal Approach: Red Oak Fund, LP v. Digirad (Part 5A)
We are discussing Red Oak v. Digirad, a Delaware case analyzing claims that arise out of the use of preliminary voting data.
The other disclosure issue concerned preliminary voting tallies provided by Broadridge. Unknown to Broadridge or Red Oak but eventually known to Digirad, the tallies included over 1 million treasury shares voted in favor of management. The shares would ultimately be exclued from the final tally.
Digirad had a stock buy back program. Apparently the repurchased shares were in an account at Raymond James. On the record date, the account contained 1,073,641 treasury shares, about 6% of the vote. Because they were treasury shares, they could not be voted.
When DTC disclosed the number of shares on deposit, the figure conflicted with the number of shares revealed in the proxy statement. The difference was, apparently, the treasury shares in the Raymond James account. Described as an "overhang," proxy solicitors for Red Oak and Digirad noticed the difference. See Id. ("An overhang meant that the DTC list of Digirad stock held in street name included more stock than the number of shares that Digirad identified in its proxy as eligible to vote.").
In early April, the solicitor for Red Oak asked whether the difference was a result of treasury shares. The proxy solicitor for Digirad indicated that it was. At least twice, the solicitor for Red Oak asked about the location of the treasury shares and received no answer. As a result, Red Oak did not know the shares were in the account at Raymond James.
Raymond James eventually received a voting request for the shares and sent it to Digirad (through Broadridge). On April 9, an employee at the company mistakenly executed the instruction in favor of management. As a result, Broadridge received instructions for the 1 million shares and listed them as votes for management. The result was to overstate management's support by 6%.
By April 15, a bit less than three weeks before the meeting, the proxy solicitors began receiving preliminary voting data from Broadridge. The data included the Raymond James shares and, as a result, overstated management's support by 6%.
Sometime in late April (the meeting was scheduled for May 3), the solicitor for Digirad "was starting to have some luck in discovering who owned the Raymond James stock." See Id. ("In an April 27 email to Keyes, [the solicitor for Digirad] seems to have concluded that Raymond James did vote Digirad's treasury stock."). The court described the solicitor as "fairly confident" that treasury shares had been voted. Indeed, the CFO sent a letter dated May 1 (the meeting was on May 3) to the inspector of elections stating that "Digirad had 1,073,641 shares of treasury stock held at Raymond James that 'should not be considered outstanding for purposes of [Digirad's] 2013 Annual Meeting.'"
The information was not conveyed to Red Oak or Broadridge. Indeed, this apparently continued through the date of the meeting when Red Oak informed its candidates that they had lost by a 46%-34% margin. Only when the final results were certified and the treasury shares backed out, was the final tally closer: 40%-34%. See Id. ("On May 10, Digirad announced the final results of the Election. The independent inspector certified that the Board had been reelected over Red Oak's slate by a vote of 40% to 34%. The 6% difference between Sandberg's May 3 email listing a result of 46%-34% and the May 10 final vote tally of 40%-34% is the Digirad treasury stock that may not lawfully be counted in a stockholder vote.").
Digirad, therefore, knew of the inaccuracy but did not tell Broadridge or Red Oak. The solicitor for Red Oak had asked at least twice about the location of the treasury shares but received no response. Moreover, evidence in the record indicated that the information was important. Red Oak testified that its strategy in large part depended upon the preliminary tallies. Id. (Red Oak solicitation strategy described "as a 'fluid process' and a 'cost[’s-]benefit' analysis that depended in large part on the preliminary results"). Red Oak asserted that knowledge of the inaccuracy would have have been a "game changer."
The issue put the court in a tough spot. The error (voting the treasury shares) was caused by the company, even if unintentional. The error benefited the company. The evidence showed that the company knew about the error.
The court hinted that the risk of faulty data was assumed by Red Oak. With Red Oak receiving data that was "preliminary," the information by its "very terms" was "subject to change and thus possibly inaccurate." But the error that occurred in this case was not typical, not expected, and caused by the company. The court did not rely on this analysis.
Instead, the court framed the issue as "novel" and described Red Oak as seeking selective disclosure of information to a single shareholder.
- The argument for a duty to disclose such information to one stockholder to use in its proxy contest strategy is unpersuasive. It clashes with the well-established principles that teach that disclosure of material information, when required under Delaware law because the directors seek stockholder action, must be to all stockholders to inform their voting decisions. Thus, if the Board owed Red Oak a duty to disclose that the Broadridge reports were inaccurate, it would have to have been a duty the Board owed to all stockholders.
The court was "loath" to find "a breach of fiduciary duty under the circumstances for such a customary and inoffensive practice without an exceedingly compelling argument rooted in Delaware law, which Red Oak has not presented." The court described the "asymmetry of information" as "an honest and unfortunate mistake, not anything approaching intentional misconduct."
The court conceded that Red Oak was disadvantaged but this was not, apparently, enough. See Id. ("Red Oak has not demonstrated by a preponderance of the evidence how a proxy solicitation strategy based on preliminary Broadridge reports inaccurately listing Digirad's inadvertently submitted treasury stock proxy amounts to an unfair election process for the stockholders at large, even if the information asymmetry disadvantaged Red Oak."). For Red Oak to prevail, it would have to show something like "intentional misconduct or self-initiated disclosure to the stockholders".
The opinion and assorted filings in the case, including the transcript of the hearing, can be found at the DU Corporate Governance web site.