Matrixx v. Siracusano: The Opinion is In

The Supreme Court ruled in Matrixx v. Siracusano, the case that had the potential to revisit the materiality standard set out in Basic v. Levinson.  The case specifically examined whether adverse event reports filed by those taking a drug would be material only if "statistically significant."  The unanimous opinion (written by Justice Sotomayor) declined to adopt the bright line test and reaffirmed the fact specific inquiry set out in Basic.  The Court noted that while something more is needed to establish materiality than the reports themselves, "that something more is not limited to statistical significance and can come from 'the source, content and context of the reports'".  The Court affirmed the Ninth Circuit's finding of both materiality and scienter.   

The significance of the case is for what it did not do.  The Court largely left undisturbed an approach to determining materiality that has been in place for more than three decades.  Law and business faculty filed an amicus brief in the case. 

SV Investment Partners, LLC v. ThoughtWorks, Inc.: Court Interprets "Funds Legally Available" for Redemption

In SV Investment Partners, LLC v. ThoughtWorks, Inc., 7 A.3d 973 (Del. Ch. 2010), preferred shareholders sought to enforce a mandatory redemption of their shares.  The provison required redemption from "funds legally available."  Preferred shareholders filed a declaratory action asserting that the phrase meant "surplus" and that the company was obligated to redeem the shares. 

The Court of Chancery, however, rejected this interpretation, holding that "funds legally available" meant cash that was "available" (cash on hand or readily accessible through sales or borrowing) and that could be deployed "legally" for redemptions without violating state or common law restrictions on redemptions.  See Del. Code Ann. Title 8, § 160.

In 2000, SV Investment Partners, LLC (“SVIP”) invested $ 26.6 million in ThoughtWorks, Inc. (“ThoughtWorks”) in exchange for 2,970,917 shares of preferred stock.  ThoughtWorks’ certificate of incorporation contained a provision that granted SVIP the right to have all of its shares of preferred stock redeemed for cash five years after their issuance from funds "legally available," subject to a one-year working capital carve-out.  In the absence of legally available funds, the redemption requirement was "continuous.” Any funds made that became legally available after exercise of the the redemption right were to be applied until the preferred stock was fully redeemed.

After the dot-com bubble burst, ThoughtWorks concluded it could not redeem the preferred stock in April 2005, and SVIP agreed to postpone exercising its redemption rights until July 5, 2005.  On that date, SVIP duly exercised its right.  The Board, however, concluded that it had no usable cash to redeem the preferred share.  A year later, in August 2006, SVIP again exercised its redemption right. In response, the Board obtained legal and financial advice and determined that ThoughtWorks had $500,000 of funds legally available and redeemed preferred stock in that amount.  In each of the subsequent sixteen quarters, the Board followed the same process to determine the extent to which funds were legally available for redemptions. Through this quarterly process, ThoughtWorks redeemed a total of $4.1 million of preferred stock. 

SVIP filed suit seeking redemption of the remaining shares.  SVIP argued that the phrase "funds legally available" was equivilant to "surplus." Under Delaware law, a corporation's surplus would be legally available for the redemption of its stock.  At trial, SVIP's expert used three standard business valuation methods to determine the amount of ThoughtWorks’ surplus, with all three methods producing surplus in excess of the amount necessary to redeem all of the preferred stock.

The court disagreed with SVIP’s assertion that "funds legally available" meant "surplus."  Reliance on surplus entailed the use of an “accounting convention” rather than a true appraisal of ThoughtWorks’ assets.  Such an interpretation would have required a redemption whenever surplus existed, even if the effect was to render the company insolvent.  As a result, not all “surplus” funds were “funds legally available.” SVIP's claim therefore failed as a matter of law.

SVIP also failed to prove at trial that the Board ever (i) acted in bad faith in determining whether ThoughtWorks had legally available funds, (ii) relied on methods and data that were unreliable, or (iii) made determinations so far off the mark as to constitute actual or constructive fraud.  The court was impressed with the diligence of ThoughtWorks’ Board in determining the amount of funds legally available for redemption, noting its consultations with financial and legal advisors and frequent evaluations of the business. Finding the Board’s process “impeccable,” the court concluded that the Board had acted responsibly to fulfill its contractual commitment to the holders of the preferred stock, and was not obligated to redeem the stock in full.

The court’s opinion concluded by pointing out that SVIP could have protected itself and "avoided its current fate" but chose not to.  As the court described: 

• SVIP easily could have protected its investment and avoided its current fate through any number of means.  SVIP decided not to, and that choice was rational at the time.  SVIP bought the Preferred Stock at the height of the dot-com mania from a technology firm with an established track record, real revenues, and actual earnings – all of which compared favorably with many issuers then embarking on over-subscribed and first-day-popping IPOs.  Everyone involved anticipated that ThoughtWorks soon would go   public at a multi-billion dollar valuation. Instead, the bubble burst. Now, with hindsight, SVIP understandably wishes it had additional rights, but “it is not the proper role of a court to rewrite or supply omitted provisions to a written agreement.”

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

John Q. Hammons Hotel and the Fairness of the Merger

In  John Q. Hammons Hotels Inc. S’holder Litig., No. 758-CC, 2011 WL 227634 (Del. Ch. Jan. 14, 2011), the plaintiffs made several allegations in connection with the merger of John Q. Hammons Hotels, Inc. (“JQH”) into an acquisition vehicle owned by Jonathan Eilian (the “Merger”).  The Merger resulted in the plaintiffs selling their Class A common stock for $24 per share. 

The plaintiffs initially made four allegations:  (1) the controlling stockholder, John Q. Hammons, breached his fiduciary duty “by negotiating benefits for himself that were not shared with the minority shareholders”; (2) the JQH directors breached their fiduciary duties by using a deficient process to approve the Merger; (3) JQH Acquisition, LLC and JQH Merger Corp. aided and abetted such breach of fiduciary duty; and (4) the proxy statement contained misstatements and omissions. 

Following trial, the plaintiffs dismissed all of the claims against the JQH directors and allowed only the claim for breach of fiduciary duty and aiding and abetting against the controlling shareholder go forward.  As a result, the court reviewed the transaction under the standard of entire fairness.  Entire fairness involved a two prong analysis of fair dealing and fair price. 

With respect to fair dealing, the court found that the process was fair.  A Special Committee consisting of independent and disinterested members with experience in the hotel industry negotiated the terms of the merger, including the price.  The Committee was thorough and deliberate and the members “understood their authority and duty to reject any offer that was not fair.”  Although the plaintiffs argued that the Special Committee was forced to accept the Merger offer, the court found no evidence to substantiate such claim. 

In considering the price, the court weighed the persuasiveness and valuation methods employed by experts on both sides and concluded that the $24 per share merger price was entirely fair.  The court ultimately relied on the expert testimony from the defendant who determined the value of the Class A shares ranged between $14.97 and $18.71.  The defendant’s expert arrived at this figure using a discounted cash flow (“DCF”) analysis, a valuation method commonly used within the financial community and accepted by the courts.  The court discounted the plaintiffs’ expert, concluding that he based his analysis on unreliable figures from management and unrealistic projections. 

In addition, the court found that because Hammons did not participate in the approval, did not participate in the Special Committee process, and did not himself make an offer, he breached no duty to the minority stockholders.  Furthermore, not only did Hammons’ conduct have no adverse effect on the consideration received by the minority stockholders, he received less per share than the minority shareholders. 

Finally, the court dismissed the plaintiff’s allegations of aiding and abetting because neither Hammons nor the JQH board breached a fiduciary duty, and the plaintiffs provided no evidence to the contrary and dismissed several claims based upon inadequate disclosure. 

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

Law School, Declining Applications, and Diversity

The WSJ reports that the number of law school applications is down.  According to the article:

• The number of law-school applicants this year is down 11.5% from a year ago to 66,876, according to the Law School Admission Council Inc. The figure, which is a tally of applications for the fall 2011 class, is the lowest since 2001 at this stage of the process. The Council estimates that the application process is 86% complete, based on historical patterns.

The numbers will likely have disproportionate impact on particular schools, particularly those that did not see this coming.  Many others will have trouble maintaining the medians for grades and LSAT scores in their their incoming class, a very important component of the rankings in the US News (which just came out).  In the aggregate, there shouldn't be significant financial difficulty for law schools.  The 66,000 applications should be enough to fill the 50,000 slots that come open in law schools each year.

But there is a potential silver lining to this drop in applicants.  Law schools have not done a good job in ensuring diverse classes.  With law schools incurring a drop in applicants, many will have to look at a wider array of candidates.  Perhaps in doing so, this will cause admissions offices and committees to consider admitting more people of color. 

Scully v. Nighthawk: Reverse Auctions and A Vice Chancellor's Unlikely Efforts at Reform (Part 4)

So where does this leave VC Laster?  With a problem that he cannot solve. 

The Brief of Special Counsel essentially told him to stay out of the matter.  Indeed, the Brief reminded the court of the consequences of intervention.  "There is also the danger that an attempt by a single court to solve these multijurisdictional issues will be resisted by other courts or avoided by litigants."

Where the Vice Chancellor suspects collusion, his only real remedy, apparently, is to convey his suspicions to the settlement judge.  This would likely occur without the benefit of a record on the issue and therefore amount mostly to speculation.  It is likely to get little attention from other judges with full dockets.  Indeed, the settlement process in Arizona in this case continues to move forward, apparently unaffected by the concerns expressed by the Vice Chancellor.  

But what about the central concerns expressed by the Vice Chancellor?  The Brief suggested that self-policing was enough.     

• the corporate litigation bar—both plaintiffs’ and defense counsel—is very much aware of the recent rulings and statements of the Court expressing, in certain circumstances, dissatisfaction with settlements and the processes leading to those settlements.  Counsel know that this Court will closely examine settlements and, where warranted, will take steps to investigate possible collusion. Special Counsel believes that much self-policing among the bar has already occurred and will continue to occur, supplemented by the continued careful consideration of settlements by this Court pursuant to Chancery Court Rule 23.

But self policing likely works only to the extent that there are consequences that can be meted out when concerns arise.  At least where the Vice Chancellor is the non-settlement judge, this does not appear to be the case. 

Moreover, while "self-policing" presumably applies to VC Laster's courtroom, it is not at all clear that the behavioral modifications will apply in others, at least until the other members of the Delaware bench express similar concerns.    

Perhaps the most unfortunate lesson from the case is one about the harm of candor.  It was only after the Vice Chancellor expressed his views on the merits that the case shifted to Arizona.  To the extent the two were causally (rather than coincidentally) connected, the solution is to avoid candor, otherwise the next communication could be notice of a settlement reached with the court in another state. 

The primary materials in the case, including the report of the Special Counsel, can be found at the DU Corporate Governance web site. 

Scully v. Nighthawk: Reverse Auctions and A Vice Chancellor's Unlikely Efforts at Reform (Part 3)

Special Counsel was also asked to apply any analysis to the circumstances in Nighthawk.  Special Counsel, therefore,  examined whether the evidence established that the settlement in the case was collusive.  The Brief concluded that it was not.  Foremost, the Brief relied on the typical nature of the process used in reaching the settlement.  As the Brief reasoned:  

• Special Counsel does not believe that the facts here lead to a conclusion that the settlement in this case was collusive. Settlements in multi-jurisdictional deal litigation are nearly always reached quickly—defendants trying to preserve their transactions need to resolve potential injunction motions before the deals close. The timing of settlement here was consistent with similar cases. The amount of fees ultimately agreed to was within the range of fees generally awarded in disclosure settlements. The amount of discovery provided to plaintiffs was similarly within the bounds of discovery often shared by defendants before settling these types of cases.

In other words, the evidence indicated that this case was handled in the usual fashion.  As such, the handling of the case did not suggest an absence of rigor.  Likewise, there was no affirmative evidence indicating collusion.  As the Brief explained: 

• there was no evidentiary support for the notion that the Delaware plaintiff’s counsel were “pushing too hard” and thereby forcing defendants to find a “weaker” or more pliable opponent. Indeed, the Delaware plaintiff’s counsel conceded that their own litigation position was weakened by their failure to seek expedition on their process claims; they did not press the claims that this Court suggested had merit.

The analysis seems correct.  In fact, there is no strong evidence indicating that counsel in Arizona and counsel in Delaware had significantly different views of the case.  Both brought a disclosure case and both presumably wanted to settle on that basis.  In other words, counsel in both states appear to have been of the same mind.  

What seems to have caused defendants to go to Arizona was not the desire for pliant counsel but, the facts suggest, the desire to avoid a judge who had already betrayed his leanings on the merits.   In other words, defendants weren't so much seeking different counsel as much as they were apparently seeking a different judge.  That issue, however, was not explored in the Brief.   

The only real discussion of the role played by the Vice Chancellor was a paragraph that indicated Special Counsel could feel his pain.  

• Special Counsel is, of course, very cognizant of the Court’s strong dissatisfaction with the settlement process employed in this case and with counsel, as expressed by the Court during the December 21, 2010 hearing. Having devoted substantial attention to the matter in considering and ruling on the motion to expedite, the Court understandably was not happy that the parties chose to present their settlement to another court. Compounding the problem was the fact that the disclosure claims on which the proposed settlement was based were claims the Court believed to be “not colorable.” The decision by counsel to settle in that manner understandably troubled the Court.

But his pain notwithstanding, it was not a basis for intervening into the settlement process. 

The primary materials in the case, including the report of the Special Counsel, can be found at the DU Corporate Governance web site.

Scully v. Nighthawk: Reverse Auctions and A Vice Chancellor's Unlikely Efforts at Reform (Part 2)

The Brief of Special Counsel contains a thoughtful and detailed discussion of the court's authority to approve a settlement as well as an analysis of the factors that should be used to determine whether a settlement was collusive.  But with regards to the concerns expressed at the December hearing, it provided little help to the Vice Chancellor. 

The Vice Chancellor was not asking about his right to approve the settlement.  He knew that he had little authority in that regard.  As he stated at the December hearing: 

• So if this settlement is presented in Arizona, that Court should absolutely rule in the first instance on whether to approve the settlement. And if that settlement is approved, again, there's no question that I will give full faith and credit to that order.

Instead, the questions posed to Special Counsel (they are here) seem more designed to determine whether, as the non-settlement judge, he had any room to explore what he thought might be a collusive settlement.  On that score, the Brief had a simple answer.  No.

The non-settling judge could seek to ensure that the settlement court had adequate information, see Brief ("the non-settlement forum should ensure that all courts involved in the multijurisdictional case are operating on the same information") and to make sure that there was an "open line of communication" between him/her and the settlement judge.  Finally, the Chancery Court could certainly "require the common parties to provide it with copies of the settlement documents filed in the settlement forum."  But beyond these ministerial functions, "[c]onsiderations of comity and judicial efficiency weigh in favor of the non-settlement forum not interfering with or second-guessing the consideration of a settlement by the settlement forum." 

Assuming that in fact, there is no room to tamper with a settlement, even when collusion is suspected (indeed proven), the Brief left unaddressed whether the Chancery Court could intervene at an earlier stage.  The settlement in Arizona has not yet been approved.  The Chancery Court is, therefore, in a position, for example, to enjoin the parties from going foward with the settlement.  That could, obviously, create a serious battle between states and courts but it is presumably within the authority of the court.  On that issue, the Brief is silent.   

The primary materials in the case, including the report of the Special Counsel, can be found at the DU Corporate Governance web site.

Scully v. Nighthawk: Reverse Auctions and A Vice Chancellor's Unlikely Efforts at Reform (Part 1)

We are in the middle of a series on the independence of the director nomination process, focusing on the recent events connected to the board of Hewlett-Packard.  But in the name of topicality, we will pick the subject up tomorrow and instead briefly touch on a different matter. 

VC Laster has made quite a splash since joining the Delaware Chancery Court.  His longstanding experience in the courts likely adds to his sometimes untraditional approach in decision making.  Nowhere has this untraditional approach been clearer than with respect to his efforts to stop what he views as inappropriate legal behavior.

In Revlon, VC Laster raised concerns about the behavior of plaintiff's counsel and replaced them.  We criticized the case not because he was wrong but because he chose to selectively criticize plaintiffs counsel for a practice that, to the extent accurately portrayed, required the complicity, if not the involvement, of defense counsel. 

In Scully v. Nighthawk, the Vice Chancellor again raised concerns about counsel's behavior and this time defense counsel was included in the analysis.  The case involved multiple suits filed over the same transaction (a merger), with at least some actions filed in Arizona and one in Delaware.  In the Delaware action, plaintiffs filed a motion for expedited proceedings apparently in an attempt to obtain injunctive relief before the merger closed.  The effort was vigorously resisted. 

 At the hearing on the motion, VC Laster apparently reviewed the merits and suggested that the disclosure claims brought by plaintiffs likely lacked merit but that other claims were more viable.  See Transcript, Dec. 17, 2010 ("Now, you also will recall that reviewing the proxy myself, I regarded the disclosure claims as not colorable. That's page 23 of the transcript. I also made clear that I thought that there were meaningful, litigable process laws in this deal."). 

Thereafter, silence ensured until the Vice Chancellor received an unexpected bit of information.

• So imagine my surprise when last Friday I got a letter informing me that the parties had agreed to a disclosure-based settlement. So, in other words, the settlement consideration was the claims that I already said weren't colorable. There was no apparent effort to address the claims that I thought were colorable. And rather than coming back to me on this, the parties had decided to go to the Arizona state courts.

Transcript, Dec. 17, 2010.  Rather than express umbrage and otherwise ignore the conern, he required additional information from the parties and appointed Special Counsel to look into the matter.  In making the appointment, he asked a number of specific questions.  The Report has now been filed and we will have some comments on it as well as some thoughts as to where it leaves VC Laster.

The primary materials in the case, including the report of the Special Counsel, can be found at the DU Corporate Governance web site.

ABA Business Law Section’s Spring Meeting & The Race to the Bottom

The Race to the Bottom is pleased to announce it will be attending ABA Business Law Section’s Spring Meeting in Boston April 14 through April 16, 2011.  At the Spring Meeting in Denver last year, we covered this event with great success and discussed many issues, which can be found here.  Additionally, we look forward to covering this year’s meeting.  We encourage followers to recommend topics or events they would like covered and discussed, a schedule can be found here.  Please follow our coverage of the Spring Meeting and look for us in Boston.

Diversity and the Board of Directors: The Inadequate Pool of Candidates for the Board

We have been writing recently about the dismal record by US boards when it comes to the representation of women.  In the US, about 12-14% of directors are women.  The usual explanation of this low percentage is the dearth of qualified candidates.  That in turn is explained by the need for directors to have executive officer (preferably CEO) experience, an area dominated by men.  We have noted on this Blog many times that this ignores plenty of other skill sets that would be invaluable to a board.  Moreover, it suggests that boards should be a "mirror image" of the CEO, something that likely weakens boards by minimizing the types of viewpoints that might come out in board discussions.

With that in mind, we notethe piece on Deal Blog by Steve Davidoff where he notes the problems that can potentially arise with directors all having the same background. As he noted:

• If the same type of people are always appointed to corporate boards, will anything change? When the next bubble comes along will these directors critically question industry practices? Or will new directors with more diverse backgrounds continue the perceptible improvement in corporate board decision-making and add value?

His suggestion?  "For all companies hiring new directors, perhaps it is time they told their search consultants that some diversity in background is appropriate."  We couldn't agree more.

Gender Diversity on the Board: The US Falls Further Behind (And Why We Need Shareholder Access) (Part 5)

The government sponsored study had issued a number of recommendations designed to improve gender diversity on the boards of listed companies.  Mostly the recommendations call for public pressure.  The recommendations include: 

1. A public commitment from the boards of the largest companies to increase the number of women to 25% by 2015 and to announce the aspirational goals within six months;
2. Changes to the UK Corporate Governance Code to require listed companies to establish a policy concerning boardroom diversity; ,
3. A call for greater pressure from investors, particularly that they consider diversity when "considering . . . appointments to the board." 
4. A broader search process for board candidates, including a commitment from executive search firms to address diversity and a willingness to expand the pool of candidates. 

The approach, therefore, seems to center on a public commitment by large companies and investor pressure to make certain that they adhere to their commitments.  Moreover, it is a position promoted by the government.  The result will likely be some increase in women on the boards of British companies.  Moreover, once a critical mass is seated, these women directors will have connections and acquaintances that can be used to locate additional women candidates.

What is happening on this issue in the United States?  The US is falling behind.  As the report described:

• under the Dodd-Frank Act Diversity Offices will implement rules to ensure the fair inclusion and utilisation of minorities and women in all firms that do business with government agencies. The US Securities and Exchange Commission introduced a new code in December 2009, requiring the disclosure of how board nomination committees consider diversity in selecting candidates for board positions.

But the Diversity Office at the Commission is on hold and the diversity disclosure requirements have not produced adequate results, as Commissioner Aguilar has noted. 

As Britain and continental Europe increase the number of women, perhaps US companies will find out whether there is a role for the market in the matter.  To the extent that more women make for better boards, the competitive position of US companies will suffer.

There is, however, some hope.  The best chances for board diversity in the US is actually something not mentioned by the study sponsored by the British government.  Shareholder access -- the rule that was stayed by the Commission and is currently being litigated in the DC Circuit -- provides a mechanism for circumventing the board nomination process.  No longer limited to friends and acquaintances of the existing board, shareholders nominating candidates will be able to select from a broader field.  It will likely involve more women and more people of color.

Gender Diversity on the Board: The US Falls Further Behind (And Why We Need Shareholder Access) (Part 4)

What are some of the observations made in the report on gender diversity sponsored by the British Government?  First, its good for business.

• This business case [of more women] is backed by a growing body of evidence. Research has shown that strong stock market growth among European companies is most likely to occur where there is a higher proportion of women in senior management teams. Companies with more women on their boards were found to outperform their rivals with a 42% higher return in sales, 66% higher return on invested capital and 53% higher return on equity.

Moreover, it increases the diversity of views on the board.  In other words, it combats problems associated with "mirror image" boards.  As the report noted:

• Boards are often criticised for having similar board members, with similar backgrounds, education and networks. Such homogeneity among directors is more likely to produce ‘group-think’. Women bring different perspectives and voices to the table, to the debate and to the decisions. Studies, stemming from Solomon Asch’s original work on conformity to majority opinion, have shown that three women are required to change boardroom dynamics, allowing them to become more vocal and their voices to be heard. Further studies have shown that the environment for women in senior roles improves once about a third of leaders at that level are female, and that a’ critical mass’ of 30% or more women at board level or in senior management produces the best financial results.

Women can improve the quality and independence of the board.

• There is a body of research which demonstrates how the appointment of female directors can improve a company’s performance. Female directors enhance board independence. Better decision-making is assumed to occur as a result of directors having a range of experiences and backgrounds. Women take their non-executive director roles more seriously, preparing more conscientiously for meetings. Women ask the awkward questions more often, decisions are less likely to be nodded through and so are likely to be better.

Then there's the notion that boards are excluding half of the most capable and talented people who could serve on the board.

• Around the world, women have become the new majority in the highly qualified talent pool. In Europe and the USA, women account for approximately six out of every ten university graduates and in the UK women represent almost half of the labour force. These are trends that British business cannot ignore. The failure of any business or economy to maximise the talents of all its people will result in below-par performance. Tapping into the under-utilised pool of female talent at board level is vital if British companies are to remain competitive and respond to rapidly changing expectations and market demands. British corporate competitiveness is at stake.

And finally, greater representation of women can positively effect the decision making process.

• A Canadian study entitled ‘Not just the right thing, but the bright thing’, looking at public, not-for-profit and private boards, found that boards with three or more women on them showed very different governance behaviours to those with all-male boards. The more gender-balanced boards were more likely to identify criteria for measuring strategy, monitor its implementation, follow conflict of interest guidelines and adhere to a code of conduct. They were more likely to ensure better communication and focus on additional non-financial performance measures, such as employee and customer satisfaction, diversity and corporate social responsibility. They were also more likely to have new director induction programmes and closer monitoring of board accountability and authority.

So what will Britain do?  It is in the cluster of countries that are more likely to defer to the market so the government is not proposing that companies should be compelled to include additional women.  We will note the study's recommendations in the next post.

Gender Diversity on the Board: The US Falls Further Behind (And Why We Need Shareholder Access) (Part 3)

The problem of inadequate gender representation is not limited to the United States.  It is effectively a global issue. 

Recognizing the failure of the market in this area, some countries have adopted a legislative solution.  Norway was the first to do so.  The government required companies to have at least 40% representation on boards of both genders.  Effectively this requires an increase in the number of women.  Norway did not do so not to improve corporate efficiency but to promote equal treatment.

Norway currently has the highest percentage of women on corporate boards.  Moreover, early reports suggest that the requirement while improving diversity has not caused harm to the business activities of Norwegian companies.  

Other countries have followed suit.  At the recent British study notes, the list of countries signing on to the Norwegian approach is growing.  They include:

• Spain – which "passed a gender equality law in 2007 obliging public companies and IBEX 35-quoted firms with more than 250 employees to attain a minimum 40% share of each sex on their boards within eight years (2015). Companies reaching this quota will be given priority status in the allocation of government contracts. There are no formal sanctions. Women made up 6.2% of boards in 2006. This proportion has risen to 11.2% in early 2011."
• Iceland – which "passed a quota law in 2010 (40% from each sex by 2013) applicable to publicly owned and publicly limited companies with more than 50 employees."
• France – wich "has passed a bill applying a 40% quota for female directors by 2016. The quotas are for 20% within three years and 40% within six years for listed companies and 40% within nine years for non-listed companies. The sanctions for non-compliance are that nominations would be void and fees suspended for all board members."
• Netherlands – "proposals were made to apply a 30% quota for men and women for larger companies. Companies would have to explain any non-compliance. This requirement would expire in January 2016."
• Canada – "Quebec has legislated gender parity for the boards of its Crown corporations and is on track to have 50% female representation by December 2011."

Moreover, the approach is likely to receive serious consideration in other countries. 

One could make the argument that this approach is occurring in countries that are less deferential to the markets and therefore more willing to have the government intervene.  In the US, however, greater deference to the markets would preclude this type of approach.  Aside from any issue as to constitutionality, quotes imposed on those in the board room would be viewed as unconscionable interference by the government into the market.  

Yet other countries with comparable deference to the markets has opted for a larger government role in promoting diversity.  A government sponsored study in Great Britain examined the issue of gender diversity and specifically rejected the approach of the non-deferential group.  Nonetheless, it suggests a series of affirmative reforms designed to raise the number of women on the board.  It goes beyond anything taking place in the United States. 

We will look at the report and the recommendations in the next post.  

Gender Diversity on the Board: The US Falls Further Behind (And Why We Need Shareholder Access) (Part 2)

The real explanation for the dearth of women is the closed system for determining nominees for the board of directors.  As we have noted often on this Blog, shareholders rarely receive a choice when electing directors.  In all but a very small number of cases, shareholders are asked to vote on the slate of directors submitted by the board of directors. 

Given the plurality system of voting, these directors will automatically be elected.  If the company has a majority vote provision in place, directors not receiving the requisite majority will nonetheless likely remain in office.  They typically must submit a letter of resignation that the board may or may not accept.  So far the tradition has been for the board not to accept the letter.  In other words, the nominees submitted by the board are almost always elected.

Increasing diversity under the present system means inducing the board (specifically the nominating committee) to nominate more women.  The committee could do so slowly, increasing the number of women nominees as incumbents step down.  Or the board could do so quickly by expanding the size of the board and adding additional women.  Either way, the front line for gender diversity is the board of directors itself. 

Foremost, fiduciary duties, as usual, are not up to the task of ensuring greater diversity.  The highly deferential approach taken to board decisions in general means that state (read Delaware) law provides no meaningful obligation to examine director qualifications and consider whether diversity would improve the decision making process.  Thus, in City of Westland Police & Fire Ret. Sys. v. Axcelis Techs., Inc., 1 A.3d 281 (Del. 2010), the state Supreme Court more or less reaffirmed the board's broad discretion to determine the qualifications of directors. 

As a result, evidence indicates that in selecting people for the board, nominating committees do not invariably conduct a broad search.  They may rely on people known to the CEO or perhaps to others on the board.  As a recent study sponsored by the British Government described:

• almost half of the directors they surveyed had been recruited through personal friendships and contacts, only 4% had a formal interview and only 1% had obtained the role through answering an advertisement. We found no evidence to suggest that this has changed substantially in the intervening years.

Given the personal and non-transparent nature of the selection process, there is little room for outside pressure.  Nor does the market have much of a role to play.  Those who rely on the market might contend that inefficient boards (due to gender disparities) would suffer in the market place (capital would become more expensive) and would eventually go out of business. 

Putting aside that this in part depends upon the market for corporate control, something hobbled and rendered almost non-existent by the Delaware courts, the approach assumes that this factor would be sufficient to drive a company out of business.  Given all of the factors that go into an investor's decision about the purchase of shares, there is no evidence that board diversity is sufficiently influential to materially effect capital raising.

Gender Diversity on the Board: The US Falls Further Behind (And Why We Need Shareholder Access) (Part 1)

In crafting a system of regulation, there is no question that the preference should be in favor of allowing markets to effectively function.  In general, markets make better decisions than regulators.  But that is not always true and sometimes the existence of market failure is easy to see.

What could possibly explain the dearth of women inside the corporate board room for US companies?  The numbers are stark.  Despite the fact that women consist of 52% of the population and are the recipients of most college degrees, they have managed to gain only about 14% of the positions inside the board room. 

Given the average size of US boards, this amounts to one per board room.  In other words, companies include a single woman on the board to avoid the embarrassment of having none (although apparently about 30% of US companies don't mind this embarrassment) but otherwise do not view an increased voice for women in the board room as a priority. 

No one, of course, says that its because men are more qualified or women cannot do the work.  They explain these low number, forlornly, by pointing out that the pool of qualified women is small and, as a result, they have no choice but to fill openings with men. 

Given that women are such a big percentage of the population, the excessively small pool argument can only be made with a straight face if the pool is defined in a way that limits candidates to areas that are dominated by men.  Thus, for example, if directors were limited to professional football players or engineers, the argument about limited number of eligible women might have some merit.  

The professional football player equivalent category for directors is the pool of CEOs and top level executive officers.  Because companies want boards with high level executive experience, an area dominated by men, they have few women to select and put on the board.  Things will only change when more women make it to the executive board room. 

But the explanation seems more like an excuse. It ignores the fact that there are categories of people with experience and expertise that can be very valuable to a board.  SOX put an emphasis on the need for financial expertise on the board, both by increasing the oversight authority of the audit committee and requiring disclosure of directors who meet the definition of financial expert.  Moreover, the need is even more important as CFOs disappear from the board.  One study of the 100 largest US companies found only seven instances of the CFO sitting on the board. 

The need for financial expertise requires directors who likely served in positions other than CEO.  It provides an additional avenue for expanding the pool of eligible women.  But finance is not the only skill needed for the board.  Banking, law, politics, and academia can provide interesting areas of expertise.  Diversity of views that might, for example, result in Exxon putting an environmentalist on the board, also would provide increased avenues for women.  A larger pool means that in fact there are plenty of women who could join a board.  So, in fact, the dearth of women is not because there is a dearth of candidates. 

What is really the explanation? 

Gender Diversity on the Board: The US Falls Further Behind

A report sponsored by the British Government has called on British companies to increase the number of women on the board.  The report is here.  It is an attempt by Britain to deal with a well known problem (women amount to only 12% of directors of large public companies, similar to the percentage in the US) but stopping short of legally mandating quotas, an approach taken by Norway and Spain and being considered by other countries.  The report puts pressure on companies to increase the percentage to 25% over the next several years.

What is going on in the US?  Dodd-Frank required an office of diversity but at the SEC that office is on hold given the financial constraints currently in place.  The SEC has required some disclosure about diversity but as Commissioner Aguilar has noted, the disclosure had not been very robust.  

We wil have more to say on this issue over the next week.  Suffice it to say, however, that the issue provides yet another justification for shareholder access.  The dearth of women, whatever the explanation, is a byproduct of the system of director nominations.  Currently that system is largely monopolized by management.  Access will to some degree weaken the choke hold over nominations and provide another avenue for increased board diversity.  

Delaware Validates "Just Say Never:" Air Products v. Airgas (The Need for Shareholder Access) (Part 3)

This case (and its counterparts, Yucaipa and Selectica, the other recent poison pill decisions), contain some real irony.  Those who support the "enabling" approach to governance have traditionally relied on the market for corporate control to keep management in check.  Yet the poison pill crippled the hostile take over market and these decisions all but kill it.

What Airgas makes clear is that a poison pill can remain in place indefinitely as long as there is a possibility of a successful proxy contest.  Moreover, the presence of a staggered board does not change the analysis.  Thus, effectively, there has to be the possibility of a successful proxy contest over a two year period.  Putative acquirors must now be prepared to pay all of the costs associated with making an acquisition (lining up the financing, paying the advisors, devoting management time to the matter), then pay the costs of a proxy contest to win one-third of the board. 

They then must spend a year in almost constant conflict with incumbent management of the target (not to mention bringing and defending against a likely bevy of lawsuits) before incurring the expenses of yet another proxy contest.  If they lose the second contest, all of the prior effort and expense will be for naught. The "for naught" will be even more likely if the company, for example, lowers the threshold of the poison pill to 5% (as in Selectica) in order to prevent the bidder from actually negotiating with other shareholders. 

Airgas in conjunction with Selectica and Yucaipa have as a practical matter mostly eliminated the market for corporate control.  Without the market for corporate control, management becomes even more entrenched.  These decisions, therefore, make it even more important that shareholders have a mechanism to remove directors who do not respond to shareholder interests.  Cases like Airgas all but prove the need for shareholder access.   

The opinion is posted on the DU Corporate Governance web site.

Delaware Validates "Just Say Never": Air Products v. Airgas (Process and Kubuki Theater) (Part 2)

In Airgas, Chancellor Chandler specifically disavows that he is adopting the "just say never" approach to takeovers where management is allowed to oppose a takeover by doing little more than adopting a poison pill and refusing to withdraw the pill. 

As he rhetorically asks:  Can "a board . . . 'just say never' to a hostile tender offer?"  He answers his own questions immediately.

• The answer to the latter question is “no.” A board cannot “just say no” to a tender offer. Under Delaware law, it must first pass through two prongs of exacting judicial scrutiny by a judge who will evaluate the actions taken by, and the motives of, the board. Only a board of directors found to be acting in good faith, after reasonable investigation and reliance on the advice of outside advisors, which articulates and convinces the Court that a hostile tender offer poses a legitimate threat to the corporate enterprise, may address that perceived threat by blocking the tender offer and forcing the bidder to elect a board majority that supports its bid.

In fact, however, his analysis proves the point. 

In the discussion over whether boards could "just say no," the argument was not whether Delaware would validate, for example, an interested officer (say the CEO) announcing that in no circumstances would a hostile tender offer ever be allowed.  This sort of self dealing behavior would be hard even for Delaware courts to swallow.

On the other hand, the courts have long shrouded director duties in a veil of process.  As long as the process is proper, the act approved is proper.  The real issue on "just say no" is whether a board, using proper process, could indefinitely prevent a hostile acquisition, even when, objectively, the board's analysis looked problematic.  Airgas validates that approach. 

To just say no, the decision needs to be procedurally correct which means decided by independent directors through the use of outside advisors.  But often this process is kubuki theater, a formalistic and staged process that otherwise has little real meaning.  Thus, for example, the decision needs to have  been made by independent directors but as we have long noted, Delaware does not insure that in fact directors labeled "independent" really are.  This is discussed at length here: Disloyalty Without Limits: 'Independent' Directors and the Elimination of the Duty of Loyalty. 

What about the process?  Again, kubuki theater.  The issue is whether there is enough paper in the file and a sufficient number of independent advisors.  Again its about process.  Moreover, the advisors may meet the Delaware definition of independent, but they have an economic incentive to give management what it wants.  As for the definition, if it were rigorous, why would Congress have to intervene in Dodd-Frank and essentially assign to the SEC the authority to define standards for compensation consultants? 

Airgas disavows that a board can just say never but then turns around and says a board can just say never if the process is right.  Assuming good lawyering, the process will always be right.  Because the process validates the decision, the decision will always be right.  And where management does not want the tender offer to succeed, the decision will invariably support management. 

The opinion is posted on the DU Corporate Governance web site.

The Merger of the NYSE and Deutsche Borse: The Appropriate Regulatory Model for Stock Exchanges

The NYSE is about to be acquired by Deutsche Borse AG.  NYSE is the junior partner and will end up with only a minority of the directors on the holding company.  The acquisition is a good time to once again reconsider the regulatory role for the NYSE. 

The NYSE was at one time an association of members (brokers and dealers) and a non-profit.  In 2006, the NYSE converted to a for profit company.  The Stock Exchange has skillfully used its public status to engage in some acquisitions, including Euronext, a collection of European stock exchanges.  As a for profit company, the NYSE has a duty to shareholders to profit maximize.  This is the case with all for profit companies.  But unlike other companies, the NYSE has regulatory obligations.  Traditionally, the regulatory responsibility has involved oversight of its members, the development of listing standards, and market surveillance.  For profit operations created tension with these duties.  Enforcing regulatory requirements was not always the most profit maximizing behavior.

When the NYSE went public, it had two broad choices with respect to regulation.  First, it could give up its regulatory role completely, allowing the government (or other self regulatory organizations) to perform the regulatory functions.  Alternatively, it could retain the regulatory functions but attempt to insulate them from the "for profit" influence. 

The NYSE opted for the latter.  It retained all of the traditional regulatory functions but gave oversight to a wholly owned subsidiary, NYSE Regulation, which was a New York non-profit.  A series of requirements were put in place designed to ensure that NYSE Regulation remained independent of the for profit holding company, most noticeably the requirement of an independent board.  They are discussed here.

As a matter of theory, the idea that a subsidiary could remain independent of the parent was never certain.  For one thing, while NYSE Regulation had considerable operational independence, its funding still came from the holding company (there was a non-public agreement about funding between the two entities).  For another, members of the holding company could sit on the board of NYSE Regulation (although they could not be a majority of the directors), providing a potential avenue for influence. 

Since becoming a for profit company, however, the NYSE has clearly reconsidered the benefits of the regulatory function.  The creation of FINRA, a the product of a merger between the NASD and the NYSE broker-dealer supervisory function, largely got the NYSE out of the broker-dealer oversight business.  Next to be jettisoned was the surveillance function.  Last year, the NYSE announced that it was contracting with FINRA to perform the function.  For more detail on all of this, go to the post here.  

The only significant regulatory function left is the development and enforcement of listing standards.  As the NYSE (and the SEC) move forward on the merger with the Deutsche Borse, it is time to consider whether this last regulatory vestige should be eliminated.  The holding company will apparently be incorporated in the Netherlands and the board will have a majority of non-NYSE directors, with Europeans dominant.  In the long term, the structure will provide some ability for European directors to influence US listing standards (perhaps by sitting on the board of NYSE Regulation). 

The NYSE should be freed from the remaining constraints of its regulatory responsibilities.  Authority to write and enforce listing standards should be transferred to the SEC.  The Agency is already deeply enmeshed in the corporate governance process and deeply enmeshed in the determination of listing standards (something confirmed by SOX and Dodd-Frank). 

eBay Domestic Holdings v. Craigslist: Wanted Enforcement of Fiduciary Duties to Minority Shareholder

In an earlier post, we reported that eBay had brought an action against Craigslist alleging breach of fiduciary duty in the Delaware Court of Chancery.  The Chancery Court decision is here. 

In 2004, eBay became a minority shareholder in Craigslist when it purchased a 28.4% shareholder position from Philip Knowlton, one of three Craigslist shareholders.  The terms of the transaction were set forth in a shareholder purchase agreement (“SPA”) which included clauses treating as confidential certain information from Craigslist, restricting the transfers of shares, requiring consent to certain transactions, and authorizing eBay to compete with Craigslist.  The SPA also required eBay's approval of a new charter that called for a three person board with cumulative voting rights.  According to the agreement, each of the three shareholders would elect one director to the new board.  eBay appointed its former CEO, Pierre Omidyar, to the board. 

In 2007, eBay started its own online classified site, Kijiji.com.  Craigslist gave eBay 90 days to shut down the site before Craigslist would take action pursuant to the SPA.  eBay refused to shut down the website.  

In response, the two controlling shareholders of Craigslist, Craig Newmark (“Newmark”) and James Buckmaster (“Buckmaster), took action.  They: 

• Adopted a rights plan that limited eBay’s ability to buy and sell Craigslist shares (“Rights Plan”)
• Amended the charter to adopt a staggered board that took away eBay’s right to unilaterally elect a director (“Staggered Board Amendments”)
• Obtained a right of first refusal over shares owned by Newmark and Buckmaster by issuing to both additional shares, thereby diluting eBay’s position from 28.4% to 24.9% (“Dilutive Issuance”)

Ebay challenged the actions.

The court ultimately concluded that the two shareholders of Craigslist breached their fiduciary duties by adopting the rights plan and by making the right of first refusal offer.   Both measures were required to be rescinded.  The staggered board provision, however, was upheld. 

The Rights Plan

The court used the Unocal test as the appropriate standard of review to analyze the rights plan.  The Unocal test placed the burden on the directors to show that their actions were reasonable.  Specifically, the directors are required to identify the corporate objectives served by their actions and reasonably justify those actions in accordance with the corporate objectives. 

Newmark and Buckmaster argued by adopting the rights plan, they were protecting their corporate culture.  The court acknowledged that the corporate cultures of eBay and Craigslist were as compatible as “oil and water.”  The court, however, rejected the argument, ultimately finding that the adoption of the rights plan to protect Craigslist’s’ corporate culture did not better serve the shareholders. 

Staggered Board Amendments

With respect to the staggered board, eBay argued that it effectively eliminated the right to cumulative voting.  With only one director elected each year, eBay's right to cumulate shares would be insufficient to elect a director to the board.  eBay argued that in adopting the staggered board provision Newmark and Buckmaster were acting not in the best interests of Craigslist but were acting in their personal best interest which harmed eBay. 

The court rejected eBay’s arguments finding Newmark and Buckmaster did not personally benefit from the staggered board amendments.  Additionally, the court noted under Delaware law, minority shareholders, such as eBay, were not required to have board representation.  Therefore, Delaware corporations did not have to ensure that cumulative voting rights actually benefited minority shareholders.  eBay, as the minority shareholder, was not deprived of any rights and consequently, Newmark and Buckmaster did not owe a fiduciary duty to eBay with regards to the staggered board amendments.

Right of First Refusal

Newmark and Buckmaster agreed to provide a right of first refusal to their shares that would continue indefinitely.  In granting the right, each would receive one newly issued Craigslist share for every five shares over which they granted a right of first refusal in craigslist’s favor.  The same opportunity was offered to eBay. 

The court found the right of first refusal and the dilutive consequences was subject to an entire fairness review.  Under the fairness review, the burden falls on the controlling directors to show the transaction was fair.  To determine if Newmark and Buckmaster’s actions were fair, they must show that the transaction was done at a fair price and the product of fair dealing. 

The court applied the entire fairness standard, noting that Newmark and Buckmaster stood on both sides of the transaction (as directors and shareholders).  The right of first refusal provided that shareholders agreeing to give Craigslist a right of first refusal would receive one additional share for each five owned.  Although offered to all three shareholders, eBay did not accept.  As a result, the company's ownershp percentage was reduced from 28.4% to 24.9%. 

The court concluded that the dilutive issue was not fair "because it requires eBay, the minority stockholder, to give up more value per share" than the other two shareholders.  Essentially, eBay, by agreeing to the right of first refusal, would have to give up the possibility that its shares would become freely transferable.  Newmark and Buckmaster's shares, on the other hand, were already encumbered (each had an option to by the shares of the other) so providing a right of first refusal to Craigslist resulted in no additional impairment of transferability.  The court held that Newmark and Buckmaster’s dilutive issuance did not serve any corporate purpose for maintaining Craigslist’s corporate culture and rescinded the dilutive issuance. 

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