Chapter 14: Shareholder Voting

Additional reading

  • When Facebook acquired WhatsApp for $19 billion in February, 2014, many outsiderssuggested that the purchase price was exorbitant. So who was responsible for this decision? Facebook is a uniquely structured corporation, with Mark Zuckerberg—the founder—retaining 57% of the voting rights of the company. Although Zuckerberg owns far less than a majority of the outstanding shares, he previously purchased the voting proxy from other investors to give him majority control. As a result, hehas a decisive say in the future of Facebook.

Chapter 15: Shareholder Information Rights

Scavenger hunt -

To give you a sense for how voting works in a public corporation, I’ve chosen the 2014 annual shareholders meeting of GE. Please look through the questions in the attached “scavenger hunt” to get a sense for the “proxy materials” used by GE for the meeting.

  • Here are the documents you’ll be looking through:
  • Proxy statement (for 2014 annual meeting)[pdf]
  • Proxy card (for 2014 annual meeting) [pdf]
  • Annual report (FY 2013)[pdf]
  • In addition, you’ll find in interesting to browse the information available on the GE "investor relations" website (typical of public corporations) and the voting results of the 2014 GE shareholders’ meeting:
  • Investor Relations - Financial Reporting
  • Voting results (4-23-14 annual meeing) / SEC Form 8-K (4-28-14)

Happy scavenging!

Overview

This chapter introduces you to --

  • how shareholders obtain corporate information under state law – namely, state inspection statutes -- to facilitate their voting and to exercise their other shareholder rights
  • disclosure by the corporation to voting shareholders as required under both state law and the federal proxy regime
  • the elements of proxy fraud actions:
  • the implied federal proxy fraud action (including the elements of materiality, culpability, reliance/causation, damages)
  • the state-based duty of disclosure and how it compares to the federal duty

Summary

The main points of the chapter are --

  • Inspection rights cover the mundane (names of directors and officers), somewhat interesting (shareholder lists) and really useful (books and records about corporate business/affairs)
  • Stockholders (record or beneficial) can seek to inspect books and records upon meeting certain procedural requirements
  • must make written request under oath
  • with proper purpose (DGCL 220)
  • often subject to confidentiality stipulation
  • must be "long" (not necessarily "net long")
  • Proper purpose must relate to a shareholder's financial interest in corporation
  • must articulate some vote, voice, sue, sell - agenda to advanceSWM
  • other purposes can exist (according to Delaware courts)
  • non-SWM purpose of antiwar activist is not valid (Pillsbury v. Honeywell case)
  • Shareholder ownership/ record list
  • in public corporations, stock held by intermediary DTC (CEDE)
  • clients of brokerage firms must not object to being revealed to management
  • inspecting shareholder receives list of ownership only if management already has them
  • Federal law, specifically SEC rules, requires that any solicitation of shareholders in a public company must include a disclosure document called a “proxy statement”
  • A “public company,” under SEC rules, is a company that has a class of securities listed on a stock exchange, or has a class of equity securities owned by 500 or more holders of record and assets of at least $10 million.
  • Public companies are prohibited under SEC Rule § 14a-9 from making “false or misleading statements” in a proxy statement
  • Federal courts have fashioned an implied private right of action under Rule § 14a-9, on the theory that the SEC cannot review every proxy statement to ensure its accuracy. [see Virginia Bankshares, Inc. v. Sandberg]

Statutes

These statutes are relevant:

  • DGCL§ 220
  • Securities Exchange Act of 1934 §14(a)
  • Securities Exchange Act of 1934 §12(b), (g)
  • Securities Exchange Act of 1934 §14a-9

Chapter 16: Public Shareholder Activism

Overview

This chapter introduces you to --

  • various theories explaining the role of shareholders in a public corporation – given the separation of ownership and control in such corporations
  • various phenomena in the modern public corporation affecting shareholder activism, including the prisoner’s dilemma and deretailization
  • shareholder voting procedures in public corporations (including reimbursement of expenses and shareholder communications) and the increasing role of institutional shareholders
  • the SEC shareholder proposal rule, its operations, and its substantive exclusions

Summary

The main points of the chapter are --

  • Public shareholders exercise their role by voting on board nominees, board-approved initiatives, and shareholder proposals
  • Shareholder activism is becoming increasingly institutionalized with large institutional investors having the loudest voice, hence control, over the corporation
  • A corporation may be required to reimburse the expenses of an insurgency proxy vote
  • Reimbursement for incumbent directors, if grounded in a policy question
  • Reimbursement for a successful insurgency, if voted on by shareholders
  • Modern movement toward reimbursement regardless of insurgency outcome
  • Federal regulations limit corporate free speech to prevent influencing shareholder voting—depending on the relationship of the speaker to the corporation, such speech may be considered a proxy solicitation
  • The shareholder proposal rule, SEC Rule § 14a-8, allows any shareholder who meets the ownership requirements, and who properly formats his proposal and submits it before the deadline, to have a proposal included in the company’s proxy materials for a vote at the shareholders’ annual meeting.
  • To be eligible to submit a shareholder proposal, a person must have continuously held at least 1% or $2,000 worth of the company’s voting shares for at least one year. The shareholder must then continue to hold the shares and present the proposal at the meeting.
  • The shareholder proposal cannot exceed 500 words, and must be submitted to the company not less than 120 calendar days before the date of the company’s last-year proxy statement
  • SEC Rule § 14a-8(i) provides thirteen substantive grounds whereby a company can lawfully exclude a shareholder proposal from its proxy materials.
  • If the company fails to include a shareholder proposal in its proxy materials, it must notify the SEC by filing the proposal and the company’s reasons for exclusion. If the SEC, upon review, determines that this exclusion is appropriate it will issue a “no action” letter. If the SEC determines that the exclusion is not appropriate, it may pursue an enforcement action against the company.

Additional reading

You can see how voting works:

  • Is corporate voting strained like political voting (see the 2000 presidential election in Florida)? There are signs the corporate proxy system may not be up to the task of dealing with custodial ownership, high trading volumes by dispersed owners, and short selling/derivatives. Is an overhaul necessary to make the system more efficient and transparent? {more >]

Statutes

These statutes are relevant:

  • Securities Exchange Act of 1934 §14a-1
  • Securities Exchange Act of 1934 §14a-8

Chapter 17: Shareholder Litigation

Overview

This chapter introduces you to --

  • the basic right of shareholders to sue and initiate litigation (this is one of the three major rights of shareholders: vote, sue, sell)
  • the two basic types of shareholder litigation: derivativeand direct
  • the requirements to qualify as a shareholder plaintiff: adequacy and standing
  • the policy considerations that arise and make shareholder litigation a controversial issue

Summary

The main points of the chapter are --

  • Shareholders have a right to sue and initiate shareholder litigation; this type of lawsuit may be derivative or direct.
  • Derivative—the lawsuit is brought by the shareholder on behalf of the corporation in which he is a stockholder, to assert rights belonging to the corporation.
  • Direct—the lawsuit is brought by the shareholder on his own behalf, to assert a violation of his rights.
  • There are special considerations for derivative lawsuits that do not apply to direct lawsuits.
  • Demand requirement—in a derivative lawsuit the plaintiff is required, pursuant to F.R.C.P. 23.1, to “allege with particularity the efforts, if any, made by the plaintiff to obtain the action plaintiff desires from the directors.” If the court decides that this demand requirement is not met then the case is dismissed.[Note: pleading “demand futility” is no longer a valid way of satisfying the demand requirement; see Aronson]
  • SLC (special litigation committee)—a committee formed on behalf of the corporation to offer a recommendation to the court of how to respond to a derivative lawsuit. The SLC is made up of independent persons (typically independent directors not named as parties, as well as hired lawyers and advisors). More often than not the SLC recommends that the casebe dismissed.
  • The standard of review for the recommendation that the SLC makes to the court may be the lenient business judgment rule (Auerbach) or a heightened standard of review (Zapata).
  • In order to initiate a shareholder lawsuit, the party must satisfy the adequacy and standing requirements.
  • Adequacy—the plaintiff must be capable of adequately and fairly representing the interests of the shareholders in a direct lawsuit or the corporation in a derivative lawsuit.
  • Standing—in order to have standing in a lawsuit, a party must have suffered an injury.In a derivative lawsuit, the injury is alleged on behalf of the corporation, and standing is limited to those with an equity interest in the corporation, which is determined on the basis of three factors: the nature of theholding, timing, and the plaintiff’s countervailing interests.
  • There are several policy issues that make shareholder litigation a controversial topic:
  • Agency costs of litigation—the plaintiffs’ attorney typically has a much greater financial stake than any individual shareholder in the outcome of the litigation, and collective action problems limit the ability of shareholders to effectively act in concert.
  • Challenges of settlements—because plaintiffs’ attorneys typically work on a contingent fee basis, they mayhave an incentive to settle rather than go to trial. In some lawsuits the best interests of the shareholders may be served by going to trial. Ultimately, it is up to the court to approve the fairness of any settlement.
  • Attorneys’ fees—the prevailing party in shareholder litigation is typically not entitled to attorneys’ fees, but when attorneys’ fees are appropriatethe attorneys may have a financial incentive eitherto settle the case more rapidly or to prolong the litigation depending upon how this award is calculated.

Additional reading

  • In April 2013, News Corp. agreed to the largest ever settlement in a derivative lawsuit: $139 million. The lawsuit alleged that Rupert Murdoch turned a blind eye to criminal activity within News Corp., and used the corporation to “pursue his quest for power, control and political gain and to enrich himself and his family members, at the Company’s and its public shareholders’ expense.”

Rules

These rules are relevant:

  • F.R.C.P. 23
  • F.R.C.P. 23.1

Chapter 18: Board Decision Making

Overview

This chapter --

  • considers the operation of the business judgment rule and justifications for the policy of judicial abstention
  • reviewsShlensky v. Wrigley, an iconic case that applied the business judgment rule in the context of a baseball team’s unprofitable decision
  • analyzesSmith v. Van Gorkom, a landmark case that addressed the fiduciary duties owed in the context of a merger decision that was purportedly uninformed
  • provides an overview of the ways that directors are insulated from personal liability: exculpation clauses, indemnification, D&O insurance

Summary

The main points of the chapter are --

  • A board of directors has a fiduciary duty to act in an honest and informed manner, in good faith and without self dealing to promote the interests of corporation.
  • Despite this relatively straightforward requirement, directors have powerful defenses to claims that they violated the duty of care or the duty of loyalty.
  • Sklensky v. Wrigley illustrates the business judgment rule at work, which protects directors from liability for business decisions even when those decisions result in losses to the corporation.
  • Smith v. Van Gorkom, a landmark case, is essential reading for understanding how courts assess the actions of a board of directors, particularly with regard to the fiduciary requirement that a board decision is “informed.”
  • DGCL§102(b)(7)—implemented by Delaware legislature in response Smith v. Van Gorkom, allows corporations to adopt charter provisions to insulate directors from personal liability for certain decisions.
  • There are three ways that directors can avoid liability for board decisions:
  • Exculpation—many states (including Delaware, see above §102(b)(7)) have initiated legislation that allows a corporation to absolve directors of monetary liability for specific types of board decisions.
  • Indemnification—the corporation is often allowed to directly pay for monetary damages that a director is held liable for, or to reimburse the director for his payment of these damages (this is also the case in Delaware; see §145). There are three types of indemnification: permissive (the corporation may indemnify the director), mandatory (the corporation must indemnify the director), and prohibited (the corporationcannot indemnify the director).
  • D&O insurance—the corporation purchases insurance policies to cover any monetary damages it may owe as a result of prohibited conduct by a director/officer (for Delaware, see §145(g)).

Additional reading

  • When News Corp., in April 2013, agreed to the largest ever settlement in a derivative lawsuit, the entire settlement was entirely coveredby D&O insurance. To some commentators, the fact that the underlying (perhaps egregious) conduct was insured raised serious issues for insurance companies providing D&O insurance.

Statutes

These statutes are relevant:

  • MBCA § 8.30
  • DGCL § 102(b)(7)
  • MBCA § 2.02(b)(4)
  • DGCL § 145

Chapter 19: Board Oversight

Overview

This chapter --

  • introducesthe “oversight” role of directors, particularly their responsibility in managing the financial and regulatory risks of the corporation
  • presentsFrancis v. United Jersey Bank, a “classic” case of director oversight in the context of a somewhat dysfunctional family-run corporation
  • dissects In re Caremark Litigation, a very important modern case that illustrates the complexities of director oversight
  • delves into Stone v. Ritter, a case that helped clarify the meaning of “good faith” action

Summary

The main points of the chapter are --

  • A corporation’s shareholders delegate the power to manage and direct the corporation’s affairs to its directors; in turn, the directors delegate some of this power to the officers and employees of the corporation.
  • A key question that arisesis how much are directors expected to do?
  • Standard of conduct—a director is generally expected to act in good faith, and in a manner that he reasonably believes to be in the best interests of the corporation. When becoming informed of impending decisions or risks, he is expected to use the care that a like person in the same position would use.
  • Another major question is what is the standard thatdirectors required to do, and when will they be held liable?
  • Liability—a director may be held liable for failing to adequately discharge his responsibility of oversight. This liabiltyoften arises not because of an affirmative act, but rather as a result of a failure to act appropriately under the circumstances.
  • The application of these principles to the conduct of directors is often very fact specific, and the case lawprovides crucial precedents for scenarios involving (wrongful) delegation, (lack of) attentiveness, and (im)proper receipt of a financial benefit.

Statutes

These statutes are relevant:

  • MBCA § 8.30
  • MBCA § 8.31
  • MBCA § 8.24
  • Sarbanes-Oxley 404

Chapter 20: Director Conflicts

Overview

This chapter --

  • provides an overview of the “traditional” duty of loyalty, which arises when a director enters into a transaction with the corporation and there is a risk of self-dealing
  • reviews statutory approaches to the duty of loyalty, along with the three factors that these statutes tend to focus on: board approval, shareholder approval, and fairness
  • introduces the corporate opportunity doctrine, which forbids a director, officer, or managerial employee from diverting a business opportunity that “belongs” to the corporation

Summary

The main points of the chapter are --

  • Contemporary statutes governing director interested transactions do not make such deals automatically invalid; rather, these statutes assume that a director may enter into a valid exchange with the corporation that does not violate the duty of loyalty
  • Safe harbor—modern statutes often attempt to create certainty for directors entering into such transactions that certain actions cannot be successfully challenged as violating the duty of loyalty. [see MBCA Subchapter F; DGCL §144]
  • Director conflict statutes typically focus on three factors to determine if an improper director conflict exists:
  • Fairness—for a potentially self-dealing transaction to be fair, the deal must be procedurally fair as well as well as substantively fair. Procedural fairness considers how the transaction was approved, the disclosure given to those making the decision, the ability of the directors to be objective, and the effect of shareholder ratification. Substantive fairness often has been distilled to a single question: “whether the proposition submitted would have commended itself to an independent corporation.”
  • Board approval—a potentially self-dealing transaction must have been approved by “disinterested” and “independent” directors. A disinterested director is one who does not receive a material benefit as a result of the challenged transaction that is greater than what is received by other shareholders. An independent director is one whose decision did not result from his being controlled by another director.
  • Shareholder approval—a potentially self-dealing transaction must be approved (or subsequently ratified) by disinterested shareholders, and the corporation must have disclosed to shareholders the material facts of the transaction and the director’s personal interest. When the interested directors are also majority shareholders in the corporation, additional complications will arise.
  • A director may violate the duty of loyalty through a transaction with a third party, if the transaction involves a corporate opportunity that “belonged” to the corporation
  • Corporate opportunity doctrine—a director, officer, or managerial employee cannot take a business opportunity for himself that the corporation could financially undertake, is within the corporation’s line of business, is advantageous to the corporation, and is one in which the corporation had an interest or reasonable expectancy.

Additional reading