Friday, October 12, 2012

Corporations Law: Shareholder Voting Outline

 Shareholder Voting Study Guide

What do shareholders vote on under state law and federal law?
  1. Electing directors
  2. Organic corporate changes such as merger, dissolution, consolidation
  3. Amendments to certificate of incorporation
  4. Shareholders vote on stock options for officers under Sarbanes Oxley (SOX).

A. State Law

Voting Procedure- because share ownership is dispersed in the large public corporation, several mechanisms have evolved to facilitate voting.
  1. Record Date
    1. A record date determines who is entitled to notice of an approaching shareholder meeting, and who is eligible to vote at it.
    2. The rapid turnover of shares on a national security exchange made the use of some fixed moment an administrative necessity.
    3. Del. § 213 requires that the record date “shall not be more than sixty days nor less than ten days before the date of the shareholders’ meeting”.
  2. The Proxy System
    1. At common law the shareholder would have to be present at the shareholders’ meeting. But with the emergence of public share ownership, personal attendance has become infeasible.
    2. Del. § 212(b) shareholders do not have to be present and can vote by proxy.
    3. Nominating a proxy has to be “in writing”. Usually the proxy is in the form of a small card-sized document signed by the shareholder.
    4. Proxies are revocable by the shareholder, who needs only to deliver a duly executed proxy card bearing a later date.
    5. Del. § 212(c) shareholders can nominate a proxy through electronic transmission so long as it can be determined that it was authorized by the shareholder.
    6. In a proxy contest, management can use the corporation’s funds for reasonable expenses. The insurgents’ expenses come out of their own pockets, unless they win and the shareholders vote to reimburse them (Rosenfeld v. Fairchild Engine & Airplane Corp.)
    7. In overview, the most important thing to understand about the proxy voting system is that it has largely superceded the shareholders’ meeting itself.
  3. “Street Name” Ownership
    1. Most investors do not register shares they purchase in their own names, but leave them registered in the name of a bank or broker.
    2. But Rule 14b-1 requires that these brokers provide the corporation with the names and addresses of its clients so the corporation can mail the annual reports and proxy materials to them.
    3. The broker is still the one who votes, as the record owners, on instructions from their clients.
  4. Stockholder Consents
    1. Permits shareholders to take action without a meeting.
    2. Del. § 228- those shareholders wishing to take action in this manner need to obtain consent of 50% plus one share.
    3. Datapoint Corp. v. Plaza Securities Co. (Del. 1985)
      1. Board can not adopt a bylaw that imposes an “arbitrary delay” upon shareholder action via consents. In this case the delay was not about the validity of the consents, but about the board’s ability to have time to change the shareholders’ minds and present alternative transactions.
      2. So what would be ok? The court says at the end of the opinion that a board of directors can adopt a bylaw that would impose minimal essential provisions for review of the validity and authenticity of the shareholder consents.

B. Federal Law and the Proxy Statement

The Proxy Statement is a creation of the Securities Exchange Act of 1934. Concerned that corporate managements would solicit proxies from shareholders without providing more than minimal disclosure about the actions to be taken at the shareholder meeting, Congress authorized the SEC to adopt rules regulating the solicitation of proxies.

§ 14(a ) provides that it is unlawful to solicit any proxy or consent with respect to a security of a registered company “in contravention of such rules and regulations as the Commission may prescribe as necessary or appropriate...”

The SEC requires that any person who wishes to solicit proxies must incur the costs of furnishing a proxy statement to each person solicited no later than concurrently with the solicitation. This makes proxy contests very expensive for someone wanting to challenge management.

Rule 14a-1 defines the terms solicit and solicitation to include:
  1. Any request for a proxy whether or not accompanied by or included in a form of proxy;
  2. Any request to execute or not to execute, or to revoke, a proxy; or
  3. The furnishing of a proxy or other communication to security holders under circumstances reasonably calculated to result in the procurement, withholding or revocation of a proxy.

What has been excluded from the definition of solicitation?
  1. Before 1992, the big exclusion was the one that you now see in Rule 14a-2(b)(2), which exempts any solicitation made where the total number of people contacted is less than 10.
  2. Rule 14a-2(b)(1) states that you can have a solicitation, and not be subject to all the proxy rules if the solicitation is sought by or on behalf of a person who does not, at any time during such solicitation, seek the power to act as proxy or request a form of revocation abstention, consent or authorization. This means that you can actively solicit on behalf of a shareholder proposal as long as you aren’t asking for proxies.
  3. The 1992 proxy reforms added Rule 14a-1(l)(2), which exempts statements by shareholders, who merely announce in the media how they plan to vote and the reasons for their decision.

C. Shareholder Proposals

As an alternative to conducting a proxy contest, the SEC’s rules also give the shareholder a low-cost alternative. Under Rule 14a-8, the shareholder can attach a proposal to the corporation’s own proxy statement, which will thus be mailed to all shareholders and voted on at the shareholders’ meeting.

Rule 14a-8(a) provides that the company must include the shareholder proposal in its proxy statement and form of proxy, subject to certain eligibility requirements.
What are the eligibility requirements?
  1. At the time of submitting the proposal, the proponent must be a record or beneficial owner of at least 1% or $2,000 of the securities entitled to vote [so holders of nonvoting preferred cannot submit proposals],
  2. and he shall have held the securities for at least a year and hold them through the date of the meeting.

Notice that there are also some other procedural requirements:
  1. The proponent or a representative must personally attend the meeting to present the proposal.
  2. The proposal must be submitted very far in advance of the meeting. For annual meetings, the rule is at least 120 days before the company’s proxy statement is released (not 120 days before the meeting).
  3. A proponent may only submit one proposal
  4. The supporting statement plus the proposal can only be 500 words.

What if the company has no basis for excluding the proposal, but it thinks the proposal is terrible? The company can include a statement in opposition to the shareholder proposal.

What if the company wants to exclude it? The company must file with the SEC a copy of the proposal and the proponent’s statement and explain why it takes the position that it can omit the proposal. The Division of Corporation Finance will issue a “no-action letter” if it concludes that the company’s omission of the shareholder proposal does not require an SEC enforcement action. If, on the other hand, the Division of Corporation Finance concludes that the company cannot omit the shareholder proposal, the Division communicates that conclusion to the company, with a brief explanation of the Division’s reasoning.

Shareholders have a private right of action to challenge the company’s omission of a shareholder proposal.

  1. Since the statute says “must”, the only way that the company can refuse to include a procedurally acceptable proposal is if one of the exclusions apply.
  2. The 3 most important exclusions:
    1. Rule 14a-8(i)(1)- The proposal is not a proper subject for action by the shareholders under the laws of the state where the corporation is incorporated.
    2. Rule 14a-8(i)(5)- The proposal relates to operations which account for less than 5% of the corporation's total assets and less than 5% of net earnings and gross sales [i.e. revenues] and is not otherwise significantly related to corporation's business.
    3. Rule 14a-8(i)(7)- The proposal concerns a matter pertaining to the ordinary business operations of the corporation. (Roosevelt v. Du Pont)
  3. Another exception is if the proposal was submitted for the purpose of promoting general economic, political, racial, religious, social or similar causes. (Medical Committee)

Historically, fewer than 10% of such social issue shareholder proposals receive 15% or more of the shares voted. Even if a shareholder proposal is not approved by the shareholders, such a proposal can be an effective public relations tool for an activist shareholder who can use a shareholder proposal to highlight a company policy to which the shareholder objects. Negative publicity associated with a shareholder proposal may ultimately pressure management to change its policies.

D. Antifraud Liability

Rule 14a-9 False or Misleading Statements- “No solicitation shall be made…containing any statement which, at the time…is false or misleading with respect to any material fact, or which omits to state any material fact necessary in order to make the statements therein not false or misleading, or necessary to correct any statement with respect to the solicitation of a proxy for the same meeting or subject matter which has become false or misleading.”

Very similar to elements of Rule 10b-5 claim.

Elements of a cause of action under Rule 14a-9:
  1. Standing
    1. Rule 14a-9 provides a private right of action. (J.I. Case Co. v. Borak)
    2. The shareholder must have been subject of the proxy statement (entitled to vote at time of proxy solicitation).
    3. But individual shareholders need not have actually read or relied upon the proxy statement. (Cowin v. Bresler)
  2. Materiality
    1. Similar materiality tests from Rule 10b-5. Whether the fact would have been important to a reasonable shareholder’s decision on how to vote.
    2. But Rule 10b-5 seeks to protect investment decisions; Rule 14a-9a, suffrage decisions. Information may not be material to share value, but may be material to the question of a director’s fitness to serve.
    3. United States v. Matthews (2nd Cir. 1986)- The court says Schedule 14A only requires disclosure of criminal convictions or pending criminal proceedings and not mere uncharged criminal conduct.
    4. GAF Corp. v. Heyman (2nd Cir. 1983)- This case involved pending civil suit against candidate by his sister. The court did not require disclosure of this proceeding, because the lawsuit was unrelated to the business of the subject corporation.
    5. Require a lot of information to be disclosed, but there is a line. Personal matters versus business related issues.
  3. Causation
    1. Mills v. Electric Auto-Lite Co. (1970)
      1. No need to require proof of whether the defect actually had a decisive effect on voting.
      2. “Where there has been a finding of materiality, a shareholder has made a sufficient showing of causal relationship between the violation and the injury for which he seeks redress if, as here, he proves that the proxy solicitation itself, rather than the particular defect in the solicitation materials, was an essential link, in the accomplishment of the transaction.”
    2. The question after Mills is what exactly is an “essential link”?
    3. Virginia Bankshares, Inc. v. Sandberg (1991)- This case held that minority shareholders whose votes were unnecessary for approval of a freeze-out merger could not establish causation. There votes were no legally needed to approve the merger. No essential link.
  4. Scienter
    1. The Supreme Court has yet to resolve whether a plaintiff must prove scienter, or only some form of negligence, to state a cause of action under Rule 14a-9
    2. Gould v. American-Hawaiian S.S. Co. (3rd Cir. 1976)- The court based liability under Rule 14a-9 on negligence. Different from Rule 10b-5, which requires a higher degree of mens rea. Rule 10b-5 talks about intent to defraud and should require a showing of intent.
    3. Adams v. Standard Knitting Mills, Inc. (6th Cir. 1980)- Conversely, the Sixth Circuit did require intent for violations of Rule 14a-9 by outside professionals, such as accountants. But this case has not been widely followed.
  5. Damages

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