Our firm has recently released a new M&A Commentary on proposals requiring an annual shareholder vote on executive compensation, known as “Say on Pay” proposals, that many public companies are likely to face during the 2008 proxy season. The Commentary, entitled “Say on Pay” Shareholder Advisory Votes on Executive Compensation: The New Frontier of Corporate Governance Activism, provides management and boards with a strategic overview of the issues these popular shareholder proposals are likely to raise–and describes the implications that will follow if the proposals pass. Among other things, the Commentary notes that:

The advent of “Say on Pay” for a company means, as a practical matter, that its executive pay policies and procedures will have to meet ISS guidelines on executive compensation or suffer a very strong risk of ISS recommending that shareholders vote “No on Pay.” Such a negative vote, if not addressed promptly by modifying executive compensation to fit ISS guidelines, will almost certainly lead to an ISS withhold vote recommendation against the compensation committee and perhaps the entire board.

The full Commentary is available online here.

The SEC’s vote affirming the exclusion of stockholder proposals seeking access to the company’s proxy to run a director election proxy fight has drawn this short and sweet applause from the attorneys most involved in the fight at Wachtell, Lipton, Rosen & Katz.

Martha Carter, who heads the design of corporate governance policies at RiskMetrics, recently gave a presentation at the Shareholder Activism class here at Harvard Law School. In her talk, Carter offered an assessment of last year’s proxy season; the issues likely to arise during the coming proxy season; and an account of the issues receiving the most attention from investors.

A video of Martha’s talk is available for download here. The materials accompanying her initial remarks can be viewed online here.

(Editor’s Note: We have hosted several posts on the SEC’s consideration of shareholder access to the ballot, including this post by Lucian Bebchuk on a comment letter submitted to the SEC by thirty-nine law professors and this post by Lynn Stout on her Wall Street Journal op-ed on the subject.)

The SEC today voted 3-1 to adopt a rule permitting companies to exclude from the corporate proxy shareholder proposals on ballot access for director elections. Although the text of the final rule is not yet available, the SEC has released a forceful speech by the lone dissenter, Commissioner Annette Nazareth, expressing her disappointment in the SEC’s decision.

The speech is worthwhile reading for anyone interested in the future of the ballot-access issue. Commissioner Nazareth’s talk concludes:

Shareholder rights face a long uphill battle with this Commission. I hope we have not completely lost the opportunity to address these issues thoughtfully. Given that all 40 of the largest markets outside the U.S. give investors in public companies the ability to nominate and remove directors, this recognition of shareholder rights is long overdue. Chairman Cox has clearly stated his intention to move forward with proxy access in the very near future. I fervently hope that is the case and that this effort succeeds in the coming year.

The full text of Commissioner Nazareth’s speech is available here.

Effective corporate governance requires reliable and consistent financial statements. Investors depend upon auditors to verify what management has done each year in innumerable corporate transactions. For decades, the American generally-accepted accounting principles (GAAP) have admirably and ably provided reliable reporting on a vast array of modern business situations.

Yet a serious drive to eliminate American GAAP, and replace them with the International Financial Reporting Standards (IFRS), is underway. A coalition has led a well-financed campaign to “dumb down” the financial reporting system that we all have grown to know, love, and trust.

Corporate management, of course, are behind this drive, hoping for their own convenience to be less accountable. This is understandable. But major American accounting firms have, surprisingly, joined with management. And the Securities and Exchange Commission, under Chairman Christopher Cox, has put more widespread use of the IFRS onto its active agenda.

…continue reading: GAAP in Peril

The Delaware Court of Chancery issued a decision last week of both practical and theoretical importance for corporate lawyers. The opinion is Melzer v. CNET Networks, Inc., and there are at least three reasons why this case is noteworthy.

First, the court held that Section 220 of the Delaware General Corporation Law, which is the statutory basis on which stockholders can demand books and records of a company, enables plaintiffs under certain circumstances to receive documents for a period prior to their stock ownership. In order to allow a pleading to be prepared with details of alleged “systemic and sustained” lack of oversight by the board (the well-known Caremark standard), the Court allowed the plaintiffs to access materials prepared before they became stockholders.

Second, the case is interesting because it began as a derivative action filed in federal court in California. The California case was dismissed by the federal judge, however, who instructed the plaintiff to avail himself of the provisions of DGCL Section 220. The parties now appear to be headed back to California, where the plaintiff will be able to amend the complaint in light of the discovery authorized in this opinion.

Finally, the case is striking because the defendant admitted that it engaged in the backdating of stock options, which is the factual basis of the underlying claims. In a separate blog post that can be found here, I offer more analysis of those facts and the court’s application of Delaware law to this fascinating case.

The SEC has been considering the issue of increased shareholder access to the corporate proxy and director elections. Labor union pension funds have been among the more vocal proponents of increased access, arguing that such access will lead to improved financial performance. Business groups, such as the Business Roundtable, have argued against increased access on the grounds that such access would encourage special-interest shareholders and would decrease shareholder value. The desirability of increased shareholder access, then, depends to a large degree on the extent to which labor unions (and other politically minded shareholders) pursue the interests of shareholder value rather than their own self-interest.

One of our Ph. D. students, Ashwini Agrawal, has written one of the first papers that addresses this issue. Ashwini noticed that in 2005, the AFL-CIO (the central federation of labor unions in the U.S.) split into two groups. Several of its member unions, representing roughly 35% of its members, left to form a new organization–the Change To Win (CTW) coalition. This exogenous shift in AFL-CIO membership allows Ashwini to examine changes in the voting behavior of AFL-CIO affiliated shareholders toward management and director nominees.

The results are striking. Ashwini finds that AFL-CIO affiliated pension funds are significantly more supportive of director nominees once the AFL-CIO no longer represents workers at a given firm (roughly 74% after versus 55% before). At the same time, AFL-CIO affiliated pension funds do not change their voting behavior when the AFL-CIO still represents workers at a given firm. Ashwini finds the opposite pattern in voting behavior for a pension fund associated with the CTW coalition. Finally, he finds no change in voting behavior for mutual funds.

These differences suggest that labor unions use their pension funds to pursue labor relations issues at the expense of shareholder value. And they suggest that there is some truth to the concerns that increased shareholder access might have unintended consequences.

Ashwini’s full paper, Corporate Governance Objectives of Labor Union Shareholders, is available for download here.

(Editor’s Note: This post comes to us from Claudia H. Allen of Neal, Gerber & Eisenberg LLP.)

We have recently released the November 2007 edition of the Study of Majority Voting in Director Elections, which demonstrates that majority voting for the election of directors, which has been characterized by its advocates as a tool for increasing director accountability, has become the prevailing election standard among large, public companies. As issuers prepare for the 2008 proxy season, a few statistics and examples drawn from the Study underscore that majority voting has become a relatively mature, as well as widespread, movement.

Majority Voting in the S&P 500 and Fortune 500. 66% of the companies in the S&P 500 and over 57% of the companies in the Fortune 500 have adopted a form of majority voting, notwithstanding robust levels of merger and acquisition activity early in 2007 that resulted in several firms with majority voting going private. By way of contrast, when the Study was initially published in 2006, only 16% of the companies in the S&P 500 had adopted a form of majority voting.

…continue reading: Study of Majority Voting in Director Elections

I recently presented my new discussion paper with Mark Roe, Public Enforcement of Securities Laws: Preliminary Evidence, at the Conference on Empirical Legal Studies at the New York University School of Law. The paper develops a measure of securities-enforcement intensity and examines financial outcomes worldwide in light of enforcement activity. The abstract of the paper follows:

The legal consequence of economic actors ignoring their legal obligations, such as laws that protect outside investors in firms, is a recurring issue. Recent scholarship examines the relative importance of private enforcement for investor protection on the one hand–via disclosure and lawsuits among contracting parties–and public enforcement on the other–via financial, regulatory, and even criminal rules and penalties. Recent financial work has seen the former to be more important than the latter. Yet much recent legal scholarship has seen private enforcement of securities laws in the United States as poorly designed, with firms–and, hence, wronged shareholders–often bearing the cost of insiders’ errors and disclosure failure. To better understand the relative importance of public and private enforcement, we here develop an enforcement variable based on securities regulators’ staffing levels and budgets. We then examine financial outcomes around the world–such as stock market capitalization, trading volume, number of domestic firms, and number of IPOs–in light of these measures of public enforcement and find that more intense public enforcement regularly correlates with strong financial outcomes. In horse races between our measures of public enforcement and the measures of private enforcement prominent in recent financial scholarship, public enforcement is typically at least as important as private enforcement in explaining important financial market outcomes around the world.

The full paper is available for download here.

(Editor’s Note: This post comes to us from Jonathan Hayter of the National Law Journal.)

The National Law Journal recently published Programmed Stock Trading Plans Eyed, which highlights recent efforts by corporate boards to ensure that executives’ stock-trading plans meet the requirements of Rule 10b5-1. That Rule permits firms to trade the company’s stock for the benefit of insiders on the basis of a predetermined plan, but corporate directors are concerned that the SEC may be preparing to bring enforcement actions on the ground that executives made changes to their plans while in possession of inside information.

Those concerns, the piece explains, stem from recent allegations that Countrywide Financial executive Angelo Mozilo, who allegedly made changes to his 10b5-1 plan in the midst of recent mortgage-market turmoil. Those claims, combined with the recent conviction of former Quest CEO Joseph Nacchio, have led boards to seek counsel as to whether their executives have made changes to the plans that run afoul of the Rule, especially because the plans are generally prepared by outside brokerage houses rather than in-house counsel or members of the board.

The SEC’s attention, the article explains, has been drawn to the issue in part by a recent study by Alan Jagolinzer of Stanford Business School. That study, which can be downloaded here, found that insiders with 10b5-1 plans managed to generate abnormal forward-looking returns larger than their colleagues who did not have such plans. Following the release of the study, the Director of the SEC’s Division of Enforcement, Linda Chatman, commented that the Commission “wanted to make sure that people are not doing [with 10b5-1 plans] what they did with stock options.” To date, the article notes, the SEC has not yet brought an enforcement case based on changes to a Rule 10b5-1 plan, but boards of directors have begun the process of learning exactly how and when an executive can make changes to such plans.

The full article is available for download here.

(Editor’s Note: This post comes to us from John L. Reed of Edwards Angell Palmer & Dodge. John has previously posted here on his 2006 Corporate Governance Litigation Review.)

On November 27, in Boston, Massachusetts, two corporate law icons–Delaware Vice Chancellor Leo E. Strine, Jr., and Wachtell Lipton Rosen & Katz partner Marty Lipton–will present their views on the current state of and trends in corporation law, as well as significant areas of concern to all directors in both public and private companies, at an upcoming breakfast event at the Boston Harbor Hotel.

Whether you are interested in director responsibilities in connection with a merger, the courts’ standard of review of director action when it comes to stockholder-voting issues, or corporate responsibility for option-pricing irregularities, this program should prove to be invaluable. Both Vice Chancellor Strine and Marty Lipton are at the forefront of shaping best practices, and they will participate in an extended question-and-answer session you will not want to miss.

This exciting program is being presented by the New England Chapter of the National Association of Corporate Directors, with the assistance of the Harvard Law School Program on Corporate Governance. Details for the event are available here, and you can register to attend online here.

In an earlier post, I discussed my recent discussion paper on loss causation in Rule 10b-5 actions. (The paper is coming out in the November issue of The Business Lawyer.) One of the issues discussed in the paper is the “true financial condition” theory of loss causation.

According to this theory (which we reject), if a negative disclosure by the firm reveals the “true financial condition” of the company that was concealed by an earlier misrepresentation then loss causation, as discussed in the Supreme Court’s decision in Dura Pharmaceuticals, has been satisfied. Our paper points out that, without a concrete link establishing that the negative firm disclosure (such as a downwards earnings projection) revealed to the market the fact that there was a prior misrepresentation, the “true financial condition” theory of loss causation largely vitiates Dura Pharmaceuticals and the loss causation requirement.

In a recent Memorandum Order in Ryan v. Flowserve Corp., the United States District Court for the Northern District of Texas has just denied class certification in a Rule 10b-5 action and dismissed plaintiffs’ claims for failure to establish loss causation. The plaintiffs relied on the “true financial condition” theory to demonstrate loss causation, and the court rejected this argument, citing our paper. (In the interests of full disclosure, I was also an expert on that case).

The Court’s Memorandum Order is available here. Our paper, The Loss Causation Requirement for Rule 10b-5 Causes-of-Action: The Implications of Dura Pharmaceuticals v. Broudo, can be downloaded here.

The Harvard Law School Program on Corporate Governance just issued my discussion paper, CEO Centrality, co-authored with Martijn Cremers and Urs Peyer. Our abstract describes the paper as follows:

We investigate the relationship between CEO centrality – the relative importance of the CEO within the top executive team in terms of ability, contribution, or power – and the value and behavior of public firms. Our proxy for CEO centrality is the fraction of the top-five compensation captured by the CEO. We find that CEO centrality is negatively associated with firm value (as measured by industry-adjusted Tobin’s Q). Greater CEO centrality is also correlated with (i) lower (industry-adjusted) accounting profitability, (ii) lower stock returns accompanying acquisitions announced by the firm and higher likelihood of a negative stock return accompanying such announcements, (iii) greater tendency to reward the CEO for luck in the form of positive industry-wide shocks, (iv) lower likelihood of CEO turnover controlling for performance, and (v) lower firm-specific variability of stock returns over time. Overall, our results indicate that differences in CEO centrality are an aspect of firm management and governance that deserves the attention of researchers.

The full paper can be downloaded here.

(Editor’s Note: This post comes to us from Lance E. Lindblom, President and CEO of the Nathan Cummings Foundation. Lance recently gave a presentation on shareholder activism at Harvard Law School; a post describing that talk is available here.) 

Along with Laura J. Shaffer, Director of Shareholder Activities for the Nathan Cummings Foundation, I have prepared an op-ed on shareholder proposals requesting improved disclosure on major corporate social policy issues, including environmental risk and health care costs. The op-ed runs as follows:

Last year, nearly 40% of the shares of Standard Pacific Corporation, one of the nation’s largest builders of homes, supported a request for disclosure relating to the company’s approach to energy efficiency. The company’s response? This issue is none of your business.

…continue reading: Corporate Social Policy and the SEC

On Monday, November 6, Ben Heineman, Jr., former General Counsel of GE, presented at the Law School’s Law and Finance Seminar. Heineman offered his insights on the role that general counsels play in corporate affairs, emphasizing how they can help ensure that the firm is managed to achieve both high performance and high integrity.

The discussion drew on two recent articles Heineman has published based on his experiences as general counsel of one of the world’s largest companies. The first, Avoiding Integrity Land Mines, was published in the Harvard Business Review last spring and is available here. The second piece, Caught in the Middle, was recently published in Corporate Counsel and can be downloaded here.

A video of Heineman’s presentation at the Law and Finance Seminar can be viewed online here.

Brian Cartwright, General Counsel of the SEC and a 1980 graduate of Harvard Law School, recently delivered an address entitled The Future of Securities Litigation. The talk offers a fascinating perspective on how we can expect securities markets–and the SEC’s regulatory approach–to change in the coming years.

The speech emphasizes what Brian calls “deretailization,” or the dwindling presence of retail investors in securities markets. Retail investors, who once owned more than 90% of publicly traded equity, now own less than 30%. Moreover, retail investors do not trade some assets at all, including the billions of dollars annually raised in 144A debt offerings. (Some institutions have recently moved to raise equity in 144A offerings as well.) And private equity and hedge funds, which frequently take publicly traded firms private, generally exclude retail investors altogether.

Over the last twenty years, Brian explains, these asset classes have come to dominate capital markets, and retail investing–once the focus of much regulatory behavior–is no longer central to modern securities markets. Instead, individual investors now choose among intermediaries competing for their funds–with the intermediaries, rather than the individual, directly participating in the capital markets.

In light of these trends, the speech argues, regulators should focus their efforts on ensuring that individuals have the necessary tools to choose among intermediaries. That kind of regulation, Brian explains, might ensure that individuals understand that a mutual fund’s past performance may not repeat itself; that additional disclosure allows investors to calculate an actively managed fund’s alpha, or market-adjusted performance; and that investors are able to evaluate a fund’s market-adjusted performance against the fund’s expenses.

The full text of the speech is available here.

Last week, in Harvard Law School’s Seminar in Law, Economics, and Organization, Professor Michael Jensen and Werner Erhard presented a paper on integrity that they co-authored with Steve Zaffron. The slides used in their talk are available here.

The abstract of their paper, entitled Integrity: A Positive Model that Incorporates the Normative Phenomena of Morality, Ethics, and Legality, runs as follows:

“We present a positive model of integrity that provides powerful access to increased performance for individuals, groups, organizations, and societies. Our model reveals the causal link between integrity as we distinguish and define it, and increased performance and value-creation for all entities, and provides access to that causal link. Integrity is thus a factor of production as important as knowledge and technology, yet its role in productivity has been largely ignored or unnoticed by economists and others.

The philosophical discourse, and common usage as reflected in dictionary definitions, leave an overlap and confusion among the four phenomena of integrity, morality, ethics, and legality. This overlap and confusion confound the four terms so that the efficacy and potential power of each is seriously diminished.

In this new model, we distinguish all four phenomena–integrity, morality, ethics, and legality–as existing within two separate realms. Furthermore, within their respective realms, each of the four belongs to a distinct and separate domain. Integrity exists in a positive realm devoid of normative content. Morality, ethics and legality exist in a normative realm of virtues, but in separate and distinct domains.

This new model: 1) encompasses all four terms in one consistent theory, 2) makes clear and unambiguous the ‘moral compass’ potentially available in each of the three virtue phenomena, and 3) provides this clarity in a way that raises the likelihood that the now clear moral compasses can actually shape human behavior.

This all falls out primarily from the unique treatment of integrity in our model as a purely positive phenomenon, independent of normative value judgments. Integrity is, thus, not about good or bad, or right or wrong, or what should or should not be.

We distinguish the domain of integrity as the objective state or condition of an object, system, person, group, or organizational entity, and define integrity as: a state or condition of being in whole, complete, unbroken, unimpaired, sound, perfect condition.

We assert that integrity (the condition of being whole and complete) is a necessary condition for workability, and that the resultant level of workability determines the available opportunity for performance. Hence, the way we treat integrity in our model provides an unambiguous and actionable access to the opportunity for superior performance, no matter how one defines performance.

For an individual we distinguish integrity as a matter of that person’s word being whole and complete. For a group or organizational entity we define integrity as what is said by or on behalf of the group or organization being whole and complete. In that context, we define integrity for an individual, group, or organization as: honoring one’s word.

Oversimplifying somewhat, honoring your word, as we define it, means you either keep your word or, as soon as you know that you will not be keeping your word, you say that you will not to those who were counting on your word and clean up any mess caused by not keeping your word. By “keeping your word” we mean doing what you said you would do and by the time you said you would do it.

Honoring your word is also the route to creating whole and complete social and working relationships. In addition, it provides an actionable pathway to earning the trust of others.

We demonstrate that the application of cost-benefit analysis to one’s integrity guarantees you will not be a trustworthy person (thereby reducing the workability of relationships); and, with the exception of some minor qualifications, also ensures that you will not be a person of integrity (thereby reducing the workability of your life). Your performance, therefore, will suffer. The virtually automatic application of cost-benefit analysis to honoring one’s word (an inherent tendency in most of us) lies at the heart of much out-of-integrity and untrustworthy behavior in modern life.

In conclusion, we show that defining integrity as honoring one’s word provides 1) an unambiguous and actionable access to the opportunity for superior performance and competitive advantage at both the individual and organizational level, and 2) empowers the three virtue phenomena of morality, ethics and legality.”

Keynote slides of the presentation are available here.

(Editor’s Note: This post comes to us from Shann Turnbull, Principal of the International Institute for Self-Governance.) 

I have recently released a new paper, entitled Correcting the Failures in Corporate Governance Reforms, in which I argue that constructive governance reform will require regulators to recognize and address the shortcomings of existing reforms. I invite readers to respond to one of the central claims of the paper: that regulators and stock exchanges cannot responsibly permit directors to retain absolute power over corporate affairs.

Among other proposals, the paper recommends that regulators prohibit corporate charters from granting directors the sort of “inappropriate powers” described by Bob Monks and Allan Sykes in Capitalism Without Owners Will Fail. For example, Directors typically are provided absolute power to manage their own conflicts of interest. As power tends to corrupt and absolute power tends to corrupt absolutely, how can regulators and those overseeing the various stock exchanges responsibly allow directors to possess such powers?

One explanation may be that regulators and exchanges have become captive of corporate interests. Monks articulates this claim in a short video available here. In my 2004 paper, Agendas for Reforming Corporate Governance, Capitalism and Democracy, I described a series of policy reforms that would give shareholders and stakeholders alike an incentive enhance the political and social legitimacy of large corporations.

Correcting the Failures in Corporate Governance Reforms posits that a contributing cause of the failure of corporate governance reforms is a knowledge gap with respect to how corporate constitutions can be designed both (1) to improve the control of complex firms to enhance their competitiveness and (2) to introduce self-enforcing co-regulation. In The Governance of Firms Controlled by More Than One Board, I offered a series of design criteria for such constitutions, based in part on case studies of self-governing, stakeholder-controlled firms.

The knowledge gap described in Correcting the Failures in Corporate Governance Reforms was pointed out by Al Gore in a 1996 speech in which he described “the growing disconnects between science and democracy.” “Page through a directory of members of Congress,” Gore noted, “and you’ll find well over 150 lawyers, but only six scientists, two engineers, and one science teacher among the 535 people in the House and the Senate. As a result, scientific concepts sometimes elude the vast majority of our elected officials.”

As I argued in The Science of Corporate Governance, the design of governance controls in modern firms is itself a scientific inquiry, requiring careful observation of the science of information and control. Yet those fields are generally ignored in the education of corporate and constitutional lawyers–as well as in the training of social scientists in schools of government, public administration and business.

One of the most fundamental principles of information science is that regulation can only be amplified indirectly through co-regulating agents. This, of course, explains the current failure of top-down regulation of corporate governance, which has taken place largely without bottom-up co-regulation by stakeholders.

Scientific analysis of corporate governance controls offers a methodology that will permit corporations to become self-governing and thus reduce the role of government in corporate affairs. Regulators would do well to incorporate that methodology as they address the failure of corporate governance reforms around the world.

Correcting the Failure in Corporate Governance Reforms is available for download here.

(Editor’s Note:  This post comes to us from Till Immanuel Lefranc at Harvard Law School. Till invites comments at till.lefranc [at] gmail.com.)  

The French Commercial Code was amended in 2006 in order to make poison pills possible in France. Only two months after the amendments were enacted, the general meeting of fifteen large companies gave its board authority to adopt a pill. Comparing French and American poison pills is interesting for two main reasons:

(1) France is likely to face same problems that the Delaware courts have been dealing with for more than twenty years. Corporate directors may have legitimate reasons for refusing an acquisition, such as finding time to obtain a higher price from a third party. But directors may also be acting out of self interest, and use the pill to entrench themselves–to the detriment of shareholders. How will French institutions regulate the pill to prevent this type of conduct from happening?

(2) On the other hand, the French pill has been carefully designed to mitigate those risks. A new pill must be approved by a general meeting of shareholders, and rights can only be issued by the board with shareholder consent. If shareholders do give the board authority to issue rights, that authority is valid for a maximum of 18 months.

I have prepared a Memorandum that sets forth a comparative analysis of the French poison pill and its implications. The Memorandum is available for download here.

(Editor’s Note: This post comes to us from Jonathan Hayter of the National Law Journal.)

The National Law Journal recently published Employers Scoring in Whistleblower Actions, which documents the consistent victories firms have enjoyed against former employees who claim the company retaliated against them for reporting corporate fraud. The Sarbanes-Oxley Act prohibits retaliation against such “whistleblowers,” but since the Act became law five years ago, only 17 retaliation complaints among more than 1,000 filed have been found to have merit.

As the piece explains, Sarbanes-Oxley’s retaliation provision only protects employees reporting a violation of the securities laws, a fraud on shareholders, or a violation of SEC regulations. One reason for employees’ low success rate, then, might be that plaintiffs have attempted to use the Act’s whistleblower protections when reporting corporate conduct not covered by the Act. Another explanation, the piece notes, might be that employers have taken greater care since the passage of the Act to avoid retaliation–and the litigation likely to follow.

The plaintiff’s bar, of course , sees matters differently, urging that a narrow interpretation of whistleblower protections has discouraged employees from coming forward in cases of corporate fraud. As the article points out, the Act requires only that a whistleblower show that he “reasonably believed” that reportable corporate conduct had taken place to be entitled to protection. Plaintiffs’ argue in the piece  that the Administrative Law Judges reviewing whistleblower cases have required employees to meet a higher standard, demanding proof that corporate fraud actually took place before affording the employee protection from retaliation.

The full article is available here.

It may not have been a Chancellor who famously said: “Predictions are difficult to make, especially about the future.” But as the Chancellor’s recent opinion in Checkfree, summarized here, demonstrates, the point is not lost in Rodney Square.

In declining to follow a path to a per se rule requiring disclosure of all projections before a merger vote can take place–Checkfree involved projections used by investment bankers in their fairness-opinion analysis–the Chancellor elegantly cabins the Netsmart opinion to a case of partial disclosure, recalling the other adage about “too much of a good thing.”

Historically, merger proposals have almost always been approved by target-company shareholders. In fact, the Wall Street Journal recently reported that, since 2003, only 7 of 1,200 transactions have been voted down at shareholder meetings.

Yet the M&A world has now seen this happen twice in the past four months. First, Carl Icahn’s proposal to acquire Lear was rejected in July, even after a last-minute increase in price. Then, on October 24, the Dolan family’s go-private proposal was rejected by Cablevision’s minority shareholders. There have also been several close calls this year, including the Inter-Tel merger, which was headed for defeat until quick maneuvering by the board gave shareholders more time to consider, and ultimately approve, the transaction. Other deals, such as the acquisitions of OSI Restaurant Partners and Clear Channel Communications were delayed, and their terms improved, to help gain shareholder support.

Shareholder opposition seems to reflect a growing sentiment that many of the deals over the past two years were undervalued–particularly private equity-sponsored transactions. It also demonstrates increased coordination among shareholders, including investors who are not traditionally considered “activists.”

Finally, these events provide evidence of the increased power of proxy-advisory firms such as Institutional Shareholder Services. ISS recommended against the Lear and Cablevision proposals. It also heavily influenced voting on the Inter-Tel merger, initially recommending against the deal and then changing its position–but only after the shareholders’ meeting had been postponed.

The failed Cablevision transaction, however, is in a league of its own, because it involved a proposal initiated by a large controlling shareholder. Through a dual-class stock structure, the Dolan family controls about 74% of the company’s voting power; and, beginning in 2005, the Dolans began trying to acquire the outstanding minority shares to take the company private. Cablevision then formed a two-member special committee, and in May the Dolans signed a merger agreement that offered a 51% premium to Cablevision shareholders and required a majority of the minority shareholders to approve the deal.

Cablevision is a Delaware corporation, so the deal was subject to entire-fairness review under Kahn v. Lynch Communications Systems. In that case, the Delaware Supreme Court held that freeze-outs are subject to entire-fairness review because minority shareholders are inherently coerced by the majority and may vote in favor of a freeze-out simply to avoid retaliation. Under Kahn, the use of a special committee and a majority-of-the-minority provision can shift the burden of proof to the plaintiff, but neither affects the standard of review. And Delaware law offers no added benefit to controlling shareholders if, as in Cablevision’s case, both procedures are employed–although this would presumably be a factor in the court’s analysis.

In a 2005 article in The Business Lawyer entitled The Dilemma That Should Never Have Been: Minority Freeze-Outs in Delaware, Peter Letsou and I argued that Delaware’s per se rule of entire-fairness review of freeze-outs should not apply in many cases. There, we rejected the notion that minority shareholders are inherently coerced by a majority stockholder, and concluded that a freeze-out should be reviewed under the business-judgment rule if:

(1) The freeze-out has been approved by a properly functioning special committee of independent directors;

(2) The freeze-out has been effectively approved by a majority of the minority; and

(3) The controlling stockholder has fulfilled its disclosure obligations and has abstained from abusive or otherwise illegal conduct.

Guhan Subramanian advanced similar arguments in his 2005 article Fixing Freezeouts. Vice Chancellor Leo Strine has also addressed the issue, offering thoughtful analysis and a proposal for reform in his opinion in the Cox Communications shareholder litigation. I also advanced a similar argument in a 2004 piece in the Virginia Law Review entitled Toward a Controlling Shareholder Safe Harbor.

The Cablevision deal is additional evidence against the needlessly broad standard of review required under Kahn, and demonstrates the ability of minority shareholders to “say no” to a controlling stockholder. It also illustrates the effectiveness of majority-of-the-minority shareholder approval conditions, particularly where there are several large minority shareholders who can work together to increase the likelihood that an undervalued proposal will be rejected.

In Cablevision, the minority shareholders got the last word–for now, at least. Delaware law would be well-served if the Delaware Supreme Court revisited Kahn in light of this evidence, easing the standard of review for freeze-outs so long as certain procedural conditions are met. This would give controlling shareholders a real incentive to utilize a majority-of-the-minority approval condition, which seems to have worked rather well in Cablevision’s case.