My colleagues R. Judson Scaggs, William Lafferty, and Jeffrey Wolters of Morris, Nichols, Arsht & Tunnell have prepared this highly insightful memorandum on the Delaware Supreme Court’s recent en banc decision in Gatz v. Ponsoldt, which held that shareholders may bring direct (as well as derivative) claims to challenge transactions orchestrated by a controlling shareholder. 

The memo is a must-read for corporate counsel and directors of firms with controlling shareholders, who are increasingly subject to direct claims for violations of their fiduciary obligations to minority shareholders.

With the able assistance of Bill Clark (one of the finest business legislation drafters around), North Dakota has adopted legislation that permits public companies to opt into a legislative scheme that includes a whole bunch of rules that are reported to be “shareholder friendly.”  Mark Roe says (and I think he’s right) that we shouldn’t expect to see companies reincorporating in North Dakota; more likely, he says, is the possibility that IPO companies will use the new North Dakota option (although Mark wisely doesn’t put money down on this either).  Some say, in any event, that this puts a whole lot of pressure on us in Delaware to do something similarly “shareholder friendly.”

The logic of this escapes me.  I’m pretty confident that if anyone thought that this North Dakota package of rules was really a good thing for a public company, they could create the same package by incorporating in Delaware (or lots of other states, for that matter) under a Certificate of Incorporation that adopted all of the North Dakota provisions.  (Section 102(b)(1) of the Delaware General Corporation Law would permit any company incorporated there to do so.)  Or, if you thought that one or two of these provisions was a bad idea, you could simply leave them out.  Some people, for example, don’t think it’s a good idea to have a permanent statutory compulsion to separate the Chairman and Chief Executive Officer positions; others might want a threshold lower than 5% (the North Dakota rule) to qualify as a shareholder eligible to get access to management’s proxy statement.

As far as I can tell, however, it’s not clear that you can pick and choose pieces you like and throw out the ones you don’t like if you adopt a corporate charter that elects to be governed by the “shareholder friendly” North Dakota statutory package.  In terms of freedom of choice, this is pretty thin soup.  Can you imagine how a good shareholder activist would respond to a board-proposed charter amendment that provided for proxy access and mandated majority voting, but at the same time created a staggered board?  You’d hear howls of unfair bundling so fast it would make your head spin.  (Unless, of course, the SEC shot it down first under Rule 14a-4 for just that reason.)  Why should bundling accomplished by the North Dakota act be viewed as more benign?

…continue reading: The North Dakota Experiment: Bundle Up!

I offer in this post some personal observations on the trial and conviction of Joe Nacchio, the former CEO of Qwest Communications, as well as some thoughts about the impact of SOX.  The Race to the Bottom has blogged the entire trial, with students or faculty attending all of the sessions. 

On Thursday, April 19, the jury found Nacchio guilty of 19 counts of insider trading (out of 42), all involving trades occurring in April and May of 2001, after the close of the first quarter.  During this time, Nacchio learned that Qwest’s ”recurring revenues” (phone, internet, and data transfer) would be insufficient for the company to meet its publicly stated earnings guidance.  Despite these warnings, Nacchio reaffirmed earnings-per-share guidance and, during the same approximate time period, sold somewhere around 1.3 million shares.

A critical issue in the case concerned the failure of Qwest to disclose that its growth was dependent on non-recurring sources of revenue, a category labeled throughout the trial as “one-timers,” or Indefeasible Rights of Use (”IRUs”).  Had this information been disclosed, it is highly unlikely that the insider trading case against Nacchio would ever have  been brought.  The disclosure obligation, of course, rests with Qwest.  Why wasn’t this information disclosed?

…continue reading: Joe Nacchio and SOX

I recently completed my final revision of a paper on The Myth of the Shareholder Franchise. The paper will come out in the Virginia Law Review later this spring together with responses to it by Martin Lipton, Jonathan Macey, John Olson, Lynn Stout, and E. Norman Veasey. The abstract of the paper is as follows:

The power of shareholders to replace the board is a central element in the accepted theory of the modern public corporation with dispersed ownership. This power, however, is largely a myth. I document in this paper that the incidence of electoral challenges during the 1996–2005 decade was very low. After presenting this evidence, the paper analyzes why electoral challenges to directors are so rare, and then makes the case for arrangements that would provide shareholders with a viable power to remove directors. Under the proposed default arrangements, companies will have, at least every two years, elections with shareholder access to the corporate ballot, reimbursement of campaign expenses for candidates who receive a sufficiently significant number of votes (for example, one-third of the votes cast), and the opportunity to replace all the directors; companies will also have secret ballot and majority voting in all directors elections. Furthermore, opting out of default election arrangements through share-holder-approved bylaws should be facilitated, but boards should be constrained from adopting without shareholder approval bylaws that make director removal more difficult. Finally, I examine a wide range of possible objections to the pro-posed reform of corporate elections, and I conclude that they do not undermine the case for such a reform.  

The article is a work that has been long in the making. It is based on the Raben Lecture in Corporate Law I delivered at Yale Law School in October 2005 and the Uri and Caroline Bauer Lecture I delivered at Cardozo in September 2005. The paper continues my work on invigorating corporate elections in The Case for Shareholder Access to the Ballot and my work on increasing shareholder power in The Case for Increasing Shareholder Power and in Letting Shareholders Set the Rules. This is a subject on which I continue to work so comments would be most welcome.

Last week the North Dakota Legislature adopted the North Dakota Publicly Traded Corporations Act.  To quote the Act’s sponsor, the North Dakota Corporate Governance Council, the Act “provides a governance structure for publicly traded corporations that gives shareholders greater rights than they currently have under other state laws.  It has been designed to reflect the best thinking of institutional investors and governance experts and addresses each of the current hot topics in corporate governance.”  A director of the Council, and the law’s drafter, is William H. Clark, Jr., from Delaware’s neighbor, Pennsylvania.

In brief, the law permits firms incorporated under North Dakota law after July 1, 2007 to elect to include a provision in their articles that they elect to be subject to the new statute.  Shareholders then get a set of provisions that looks like a shareholder rights advocate’s wish list, including majority voting for directors, advisory shareholder votes on executive compensation committee reports, a right for certain shareholders to propose board nominees on the company’s proxy statement; reimbursement of proxy expenses to shareholders to the extent they are successful in getting nominees elected; a requirement of a non-executive board chair; and restrictions on poison pills and other takeover devices.  The Economist recently applauded the Flickertail State’s plan “to poach company incorporations from Delaware” as “injecting some much-needed competition into the field of corporate law and governance.” 

As a longtime champion of state corporate competition, I suppose I should be happy to see this development.  Isn’t it an example of what Roberta Romano has called The Genius of American Corporate Law? Isn’t it, after all, an answer to those who say that we need to federalize corporate law to get reform?  Doesn’t it provide a natural experiment to see whether corporations really want the reforms that have been proposed?  Well, sort of.

…continue reading: The North Dakota Experiment

Several readers have inquired as to whether we could arrange to notify you by email when one of our contributors has added something new. We’ve now arranged for FeedBlitz to update our readers by email each time we’ve added a new post.

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As most proxy season observers know, one of the oldest tricks in the book for defusing angry shareholders is to hold the annual stockholders’ meeting in some far-flung location, as noted in this recent Wall Street Journal article.  I’ve blogged about this topic once in a blue moon (or left comments on other blogs).

With the growing importance of annual shareholder meetings–due to the majority-vote movement and the potential elimination of broker non-votes in director elections–I believe it’s simply too risky from an investor relations perspective for any company to hold their meeting at an inconvenient location.  It’s only a matter of time before some bright journalist starts an annual “Top Ten Inconvenient Locations” list.  Trust me: no company wants to experience the heat that Home Depot did for its various annual meeting snafus last year…

At last week’s Law and Economics Seminar, Mark Roe presented a fascinating new paper (coauthored with Jordan I. Siegel) called Political Instability and Financial Development.  Unlike previous work, which largely attributes financial development to legal origin, Professors Roe and Siegel argue that political stability, at least in part, explains differences in development across countries.  The Abstract explains:

Political instability impedes financial development and is a primary determinant of differences in financial development around the world.  Conventional measures of political instability–such as Alesina and Perotti’s well-known index of instability and a subsequent index derived from Banks’s work–persistently predict a wide rang of national financial development outcomes for recent decades.  These results are quite robust to legal origin, to trade openness, to latitude, and to other measures that have obtained prominence in the past decade.  These findings are for a range of key financial outcomes for all available years and for all available countries over several decades–data that has been previously examined only partially.  Surprisingly, despite the widespread view in the law and finance literature of legal origin’s importance, not only is political stability highly robust to legal origin, but, for many years, our results for key indicators and specifications neither show Common Law to be consistently superior nor French Civil Law to be consistently inferior to other legal families in generated strong financial development outcomes.  The robust significance of political stability tells us that there are powerful channels to financial development running through political stability that go a long way toward explaining cross-country differences in financial development.

…continue reading: Does Political Stability Lead to Financial Development?

Fortune magazine has an article about Lucian Bebchuk in its current issue. The article, by Geoffrey Colvin, Fortune’s senior editor at large, discusses both Bebchuk’s bylaws initiative and his academic work. Below is the profile:

A Corporate Governance Gadfly Irks CEOs: Lucian Bebchuk’s Shareholder Initiatives are Shaking Corporations.
by Geoff Colvin

He insists he isn’t an activist. Plenty of America’s CEOs must hope he means it. “I’m mainly a kind of ivory tower academic,” says professor Lucian Bebchuk of Harvard Law School, and that he surely is - the only person I know of with four graduate degrees from Harvard (master’s and doctoral degrees in law and economics).

But as director of the school’s Program on Corporate Governance he has also become America’s most influential critic of CEO pay–to the deep annoyance of many CEOs, who say privately they wish he’d just be quiet. So now that he’s behaving like a shareholder activist as well for the second proxy season in a row, the mere suspicion that it could be a new career cannot be comforting.

Bebchuk is best known for careful research that skewers the way CEOs get paid. From the bosses’ perspective he has been distressingly energetic, not only writing a book (Pay Without Performance) but also delivering lectures, contributing op-ed pieces, conducting seminars and testifying before Congress.

Then, starting last year, he got into the game directly and changed it. Based on a particularly astute reading of corporation law that’s too complicated to describe here, he filed a proposal with CA (formerly Computer Associates), to be voted on by shareholders at the annual meeting, that would change CA’s bylaws regarding the so-called poison-pill takeover defense. Bebchuk and many others see that mechanism as a management entrenchment device that hurts shareholders. His proposed bylaw change would let CA adopt a pill, but only by unanimous vote of the board, which would have to reaffirm the vote unanimously every year.

…continue reading: A Corporate Governance Gadfly

American International Group (AIG) and I have reached an agreement under which the company will amend its bylaws to require that CEO compensation be ratified by a majority of independent directors.

Last December I submitted a shareholder proposal to amend AIG’s bylaws. Under the proposed amendment, CEO compensation would not only have to be approved by the company’s compensation committee but also by three-quarters of the company’s independent directors.

In discussions I subsequently held with AIG, AIG informed me that it will adopt a guideline requiring that CEO compensation be approved by a majority of the company’s independent directors, and AIG’s board indeed adopted last month revised governance guidelines containing this provision. Although AIG urged me to withdraw my proposal in light of its willingness to adopt the guideline, I felt that doing so would not be appropriate given that the guideline did not incorporate two key elements of the approach I favor: (1) adoption via a bylaw rather than merely a guideline; and (2) using a super-majority rather than a majority requirement for independent director approval. In subsequent discussions with AIG, we reached a compromise under which the company agreed to adopt element (1) but not (2).

In particular, AIG and I reached an agreement under which my proposal will be withdrawn and a specified bylaw will be proposed for approval by the AIG Board of Directors at its next regularly scheduled meeting, and would be effective immediately upon approval by the Board of Directors. Under the specified bylaw, which would be added as the new Section 2.11, the determination of CEO compensation will be subject to approval or ratification by a majority of the non-employee directors on AIG’s board.

…continue reading: AIG Agrees to Amend its Bylaws

In the weekend edition of the Wall Street Journal, Jonathan Macey (deputy dean at Yale Law School) embarked on an assault on SOX in an article entitled What Sarbox Wrought.  He describes the Act as an “intrusive, circulatory and duplicative grab-bag of rules” and concludes that, because of the adoption of SOX, it is “now fashionable for issuers to avoid U.S. markets.”Put aside that there is evidence suggesting that companies are moving overseas because of the improved quality of foreign trading markets–something one would think would win accolades from those who rely so extensively on market solutions.  Put aside that the decline in IPOs in the US predated the adoption of SOX and that some evidence suggests that the percentage is again increasing. 

The most interesting thing about the editorial is that the proposed solutions are not directly related to SOX at all.  Macey dismisses recent efforts to decrease the costs of compliance with Section 404.  Instead, he calls for a reduction in the “[m]assive litigation risks” and the underwriting fees that “are an order of magnitude higher in the U.S.” than elsewhere.

SOX did not increase underwriting fees, and the so-called “massive” litigation risk predated the Act (it was, after all, the impetus for the PSLRA).  If anything, the data on the Stanford Securities site (and the opinions of Joe Grundfest) suggest that, in a post-SOX world, litigation risks (at least as measured by the number of securities suits filed) are declining (2006 had the lowest number of securities class action fraud suits filed since 1996).  There is at least room to argue that independent audit committees and truly independent auditors have reduced the instances of mistake and fraud, causing a decline in litigation.

…continue reading: Jonathan Macey and SOX

A few weeks ago, I blogged about SEC Chairman’s Cox’s first comments on incoming executive compensation disclosures under the new disclosure rules.  Chairman Cox recently gave another speech further explaining why he believes that executive compensation disclosure, and particularly the CD&A, is not in plain English.  The part of the Chairman’s speech that deals with compensation disclosures is quite long.  Below are just a few excerpts to give you a sense of his message:

- “I have to report that we are disappointed with the lack of clarity in much of the narrative disclosure that’s been filed with the SEC so far.  Based on the early returns, the average Compensation Disclosure and Analysis section isn’t anywhere close to plain English.  In fact, according to objective third-party testing, most of it’s as tough to read as a Ph.D. dissertation.”

…continue reading: SEC Chairman Cox Expounds on CD&A and Plain English

Yael Hochberg, Paola Sapienza, and Annette Vissing-Jorgensen have a new study, A Lobbying Approach to Evaluating the Sarbanes-Oxley Act of 2002, that pursues a novel and interesting approach to assessing SOX.  The Abstract of the paper is as follows:

We evaluate the net benefits of the Sarbanes-Oxley Act (SOX) for shareholders by studying the lobbying behavior of investors and corporate insiders to affect the final implemented rules under the Act.  Investors lobbied overwhelmingly in favor of strict implementation of SOX, while corporate insiders and business groups lobbied against strict implementation.  We identify the firms most affected by the law as those whose insiders lobbied against strict implementation, and compare their returns to the returns of less affected firms.  Cumulative returns during the four and a half months leading up to passage of SOX were approximately 10 percent higher for corporations whose insiders lobbied against one or more of the SOX disclosure-related provisions than for similar non-lobbying firms.  Analysis of returns of the post-passage implementation period indicates that investors’ positive expectations with regards to the effects of the law were warranted for the enhanced disclosure provisions of SOX.

The full Article is available for download here.