(Editor’s Note: The post below by Commissioner Walter is a transcript of remarks by her at the Society of Corporate Secretaries and Governance Professionals on June 27, 2009 in San Diego.)

I am delighted to participate in this year’s conference. And, I particularly appreciate your willingness to change the placement of this speech in your program so that I could attend.

I have enormous respect for this Society and its members. In fact, once, long before there were governance professionals, I persuaded David Smith to allow me to join the Society, even though I have never served as a corporate secretary. Although that was years ago, I am delighted to see that there are still familiar faces here today. Most important, as I’ll highlight later, each of you sits at a critical juncture in our corporate governance system.

For those of you whom I haven’t met before, I am a New Yorker by birth, a Washingtonian by trade, and a future Mainer when I retire, but at the moment, my heart is in San Diego, not only because I’m standing before you today, but because both of my sons are living here right now.

Although I returned to government as an SEC Commissioner a little less than a year ago, I now stand second in seniority among our Commissioners. I am not an SEC or securities law newbie, however. I spent 17 years at the Commission in the Office of General Counsel and the Division of Corporation Finance before serving as General Counsel at the CFTC and Senior Executive Vice President, Regulatory Policy & Programs, at FINRA.

I know that each of you is living through the excitement and perils of changes in our legal, regulatory, and business landscapes. We in government are as well. There are a wide range of important issues before the Commission now, but, given that I am the only thing standing between you and the fabulous weather outside, I’d like to focus my comments today on just a couple of topics affecting corporate governance that are very important to me – shareholder access and the role of the corporate secretary as internal gatekeeper.

Before I get too much further, though, let me give you the standard disclaimer that the views I express here today are my own and do not necessarily reflect the views of the Securities and Exchange Commission or my fellow Commissioners. [1]

…continue reading: The American Corporation and its Shareholders: Dooryard Visits Disallowed?

(Editor’s Note: The post below by Commissioner Paredes is a transcript of remarks by him at the Center for Capital Markets Competitiveness, U.S. Chamber of Commerce on June 23, 2009 in Washington, D.C.)

It is a pleasure to be speaking at this timely conference on “Shareholder Rights, the 2009 Proxy Season, and the Impact of Shareholder Activism” hosted by the U.S. Chamber of Commerce. Before I begin, I must remind you that the views I express here today are my own and do not necessarily reflect those of the U.S. Securities and Exchange Commission or my fellow Commissioners.

As a practical matter, public company shareholders are not well-positioned to run the enterprises in which they invest. Managerial responsibility over a firm’s corporate strategy and day-to-day business and affairs instead is in the charge of directors and management. That said, shareholders retain the right to vote on fundamental corporate changes, such as a merger, a sale of all or substantially all of the corporation’s assets, and an amendment to the corporate charter or bylaws. Most notably, shareholders vote for board members. Shareholders also have the right of “exit,” as they can sell their shares if they disapprove of the company’s performance.

The animating question behind any discussion of shareholder rights thus presents itself: What is the proper institutional arrangement for ensuring that the company is managed in the best interests of shareholders when those who own the firm do not actively run it? [1]

Last month, in May, the SEC took a significant step toward setting the balance of control in corporations. [2] The Commission proposed new Exchange Act Rule 14a-11 creating a direct right of access for shareholders to the company’s proxy materials for nominating board members. For example, for the largest public companies, a nominating shareholder or group would have the right to include director nominees in the company’s proxy materials if the shareholder or group beneficially owned at least one percent of the company’s shares for at least one year.

The Commission also proposed amending Exchange Act Rule 14a-8(i)(8) to allow shareholders to include in the company’s proxy materials a proposal to amend the company’s bylaws to provide for a shareholder access regime. Notably, the SEC’s proposal prohibits shareholders from adopting a bylaw that opts out of the Rule 14a-11 access regime, even if shareholders want to.

As you may know, I voted against the Commission’s proposal and instead offered a counterproposal, which I will discuss later. [3] First, let me explain my core concern with what the SEC has advanced. As always, I look forward to considering the comments we receive on the proposal.

…continue reading: The Proper Limits of Shareholder Proxy Access

(Editor’s Note: This post is by Charles Nathan, Alex Cohen, Brian Miller of Latham & Watkins LLP and Rhonda Brauer of Georgeson Inc.)

On June 10, 2009, the SEC published a proxy access rule proposal for public comment. The Commission’s release, entitled “Facilitating Shareholder Director Nominations,” gives concrete form to the broad objectives the Commission outlined at its May 20, 2009 open meeting (at which it approved publication of the rule by three votes to two).

As expected, the SEC is proposing to:

· create a new Rule 14a-11 that would require companies to include shareholder nominees for directors in company proxy materials under prescribed circumstances, and

· revise existing Rule 14a-8(i)(8) to allow shareholder proposals to amend a company’s governing documents regarding nominating procedures or disclosure related to shareholder nominations, thus reversing the SEC’s 2007 prohibition on using Rule 14a-8 for shareholder proxy access proposals.

Proposed Rule 14a-11

The key features of the proposed rule are as follows:

· Companies Subject to Proxy Access: The proposed rule would apply to all Exchange Act reporting companies subject to the proxy rules, regardless of their size, including investment companies and companies that have voluntarily registered their stock (under Section 12(g)) but excluding debt-only issuers and foreign private issuers.

· Minimum Ownership: The proposed rule would set a tiered minimum-ownership requirement for shareholders seeking to nominate directors:

· Minimum Holding Period: Each nominating shareholder would be required continuously to have held the requisite number of shares for at least one year prior to the date it notifies the company of its intent to nominate a director, and must intend to hold the shares at least through the date of the annual or special meeting.

· Aggregation: Unaffiliated shareholders would be permitted to aggregate their holdings to meet the minimum share ownership threshold. There is no limit on the size of a nominating group. Communications for the purpose of forming a nominating group would be exempt from the proxy rules, provided they are limited in scope, do not request or solicit actual proxies and are filed with the Commission.

· Beneficial Ownership Reporting: The formation of a nominating group holding in excess of 5 percent of an issuer’s equity securities would still be required to be reported under Regulation 13D. However, the formation of a nominating group would not affect any group member’s otherwise existing eligibility to file on Schedule 13G rather than 13D. Moreover, an amendment to Rule 13d-1 would specifically allow groups formed solely to nominate a director pursuant to Rule 14a-11 to file on Schedule 13G.

· Timing of Nomination: Nominations would need to be submitted to the company on the same time schedule as Rule 14a-8 proposals (i.e., no later than 120 days prior to the date of publication of the prior year’s proxy material), unless a company’s advance notice bylaws provided for a shorter period.

· Mandated Disclosure and Filing: Each nominating shareholder (including each shareholder within a nominating group) would be required to represent as to a number of items, including that:

…continue reading: Proxy Access Proposed Rules Published by SEC

Walking to the Myerson Symphony Center past the various galleries, statues and plantings in the Arts District of downtown Dallas during the last week of May is a contemplative experience for me. As a Boston Irishman, I cannot but remember the fate of Jack Kennedy in this seemingly gentle, indeed beautiful, city. Living now year round on the coast of Maine where the leaves around my house are yet to flower, immersion in the foliage and scent of high spring are intoxicating. I am on my annual pilgrimage to the Annual Meeting of shareholders of the most profitable corporation in the history of the world – ExxonMobil. In times past, there was a subdued sense of violence. There was still the careful organization of crowd control barriers, uniformed and other police, the combination of horses and motorcycles, the almost robotic protest by the seemingly inevitable protesters, the politely insistent ticket issuers, takers and the possession examiners – resulting this year in the loss not only of my Blackberry but also of my small brief case except for the few pages I was allowed to retain when I protested that without props memory failure at my advanced age would not allow my presentation of the five motions – I waved the green tickets that proved my entitlement to have the floor for five times three minutes – without embarrassment to all.

Inside, all was a well organized exhibit of Exxon’s presence, together with an extremely lavish offering of coffees and various pastries. My long time friend Jamie Houghton was there for his last board meeting. He is very patient with me – our fathers were Harvard College Classmates and members of the Chapter of the National Cathedral – and we enjoy the exchange of views of civilized persons with diametrically opposed world views. I saw Rex Tillerson and tried to get close, with no success, but – to be honest – there was no visible precaution against our meeting.

Annual Meetings are one of the least commented upon contradictions in contemporary capitalism. Statutes advertise them as the time and place for management and owners to meet; for corporate executives to account for their stewardship of the investors resources; and for the shareholders to have the opportunity to hold these managers to account. The reality, alas, is otherwise – the preponderance of votes on all the business items have already been received by proxy and there is absolutely no chance that anything that occurs in the next several hours will affect the pre ordained results. That said, there is a certain charm to the choreographed process analogous to watching a theatrical performance embedded in our cultural memory – like Shakespeare or Corneille. The numerical result is not the object of the event. What needs to happen is that shareholders and managers have together to conjure up a myth of importance – something real is happening (Santa Claus will come tonight!). In the occasional interplay between management and questioners, a sense of the soul of the corporation is expressed. In the process by which the meeting is conducted a sense of the standards of decency are proclaimed. In the brief passages – presentations are limited to three minutes, and Exxon management for the second year in a row – notwithstanding my ignored letter of protest – will not permit human responsive discussion.

I asked Rex Tillerson, Chairman and CEO, whether I could modify the rules governing the presentation of shareholder proposals in order more clearly to explain a new development of general interest. I was the designated presenter for the first five proposals, and, therefore, entitled to fifteen minutes. Tillerson looked bewildered, conferred with corporate secretary Rosenbaum, and said: “We’ll see where you are after the first three minutes”. It was only later that I came to understand that Tillerson’s entire concern was to limit the “tax” of time that law imposed on Exxon’s top management requiring exposure to their owners and that his hesitation has nothing to do with the content of what I was saying. There was nothing I could say that would interest him in the least. It is sad that these fine engineers cannot conduct themselves so as to save participants in this meaningless meeting of any dignity. Exxon considers shareholder relations as a non cost effective demand on executive time. When a shareholder pointed out that as a New Jersey corporation, Exxon might consider holding meetings in that state, Tillerson pointed out “I like Texas” and, so it is – the CEO’s world.

Tillerson’s Exxon executives examined the New Jersey statute and instructed staff to do everything legally possible to limit the diversion of valuable CEO and director time. New Jersey requires an Annual Meeting, at which directors are elected. The SEC requires that Exxon include on its Annual Meeting proxy resolutions, deemed appropriate by the Commission. The company relentlessly challenges all resolutions before the Commission, requiring not insignificant legal expense for those wishing to advance their proposals. They induce law firms with fine names to opine to the SEC that even proposals like mine – plain vanilla in the world of corporate governance – are in violation of law and regulation. The SEC of years past will accede to Exxon’s experts unless I adduce comparable legal weight- and so, I do at a cost not far off $100,000. There is implicit in the SEC rules that proponents be allowed to present their resolutions to the meeting. Over the last several years, Exxon has massaged the choreography of the meeting so that all proposals are presented without any questions or interruptions beyond Tillerson’s mantra that “Management opposes this resolution, etc.” following each presentation. There then follows a random question period during which no exchange of views is possible. Tillerson doesn’t deign to answer questions, nor does he permit any of the board members to answer questions directed at them. A certain punctilio is always observed – all the company directors are present and non-participating, the company’s “performance puff piece” is aired for an hour, the Chairman and Secretary smirk and chat sometimes allowing speakers to talk through the red light signals.

Several of the proposals concerned the long time disagreement between Exxon and important shareholder constituencies who are concerned with the company’s policies towards climate change and alternate energy. This interest in climate culminated in the impassioned presentation of Father Mike who reminded Tillerson of the company’s commitment to the conclusion that man, and Exxon, in particular, were contributants to the problems of global warming. At this point, almost by magic, individuals were recognized who trashed all sentiment having to do with global warming or criticism of EM management. Father Mike rose again to ask Tillerson not simply to acquiesce in these public expressions of opinion that the company, on the record, opposed. He appealed to moral imperatives, to the obligations of leadership not to enable dissemination of false information. Tillerson was unmoved.

Essentially, Exxon’s view is that the shareholder meeting is an utter waste of time which they are legally compelled to endure. So, smirking and with time watch, they absolutely do not gave a tinker’s dam what anybody says, as it is all an imposition. I could feel this at the beginning when I actually tried to say something of importance to Exxon about the current state of governance – Tillerson could care less about anything any of us have to say as long as the time limits were observed. Sometimes my naïve optimism appalls me. For many years, I have felt it important to appear at these meetings as a “witness” to the atrocities of governance. I have now come to feel that one of the reasons I feel sick after these meetings is that I really am being an “enabler”. Appearing at this 2009 version of a show trial tends to legitimate it. Actually, the perfect epitaph for this experience is the ritual by which the Corporate Secretary casts votes for resolutions when no proponent is present – it is in that mode that I will be present in future years. The engineers will have saved three minutes!

(Editor’s Note: This post is from Eric S. Wilensky and Angela L. Priest of Morris, Nichols, Arsht & Tunnell LLP.)

In the current recessionary environment, rather than looking outward for the next big deal, many corporations are turning their focus inward, reviewing and shoring up their own governance structures, defensive mechanisms, indemnification schemes and governing documents. Knowledge of recent Delaware jurisprudence is helpful in such a review, as in numerous instances over the past year, the Delaware courts have released opinions addressing and interpreting corporate charter and bylaw provisions and indemnification agreements. This article surveys the relevant Delaware developments, which are summarized briefly below.

Bylaw Provision Cases

Bylaw provisions were a hot-button issue in 2008, with Delaware court opinions touching on advance notice, proxy expense reimbursement and indemnification and advancement provisions. Two of the most talked-about corporate opinions of 2008, JANA Master Fund, Ltd. v. CNET Networks, Inc. and Levitt Corporation v. Office Depot, Inc., focused on the legal interpretation of advance notice bylaw provisions, making clear in each case that the Delaware courts will likely construe such provisions strictly, and where ambiguous, in favor of the stockholder franchise.

The Delaware Supreme Court, on certification from the SEC, also weighed in on the legality of proxy expense reimbursement bylaw provisions in CA, Inc. v. AFSCME Employees Pension Plan, and the Delaware legislature thereafter approved amendments to the DGCL that will specifically allow corporations to include proxy reimbursement and proxy access provisions in their bylaws.

Finally, numerous opinions by the Delaware courts involved the interpretation of indemnification and advancement bylaw provisions. Specifically, the Court of Chancery discussed when indemnification and advancement rights vest (spurring the approval of legislation that clarifies this issue) and provided guidance on “fees on fees” awards in Schoon v. Troy Corp. The Delaware Court of Chancery also interpreted the terms “defense” (Reinhard v. The Dow Chemical Company, Zaman v. Amedeo Holdings, Inc., Duthie v. CorSolutions Medical, Inc. and Sun-Times Media Group, Inc. v. Black), “agent” (Jackson Walker LLP v. Spira Footwear, Inc. and Zaman), “proceeding” (Donohue v. Corning) and “final disposition” (Sun-Times), which terms consistently appear in indemnification and advancement bylaws.

Charter Provision Cases

In 2008 and early 2009, the Delaware courts also addressed Section 102(b)(7) charter provisions (limiting monetary liability for directors for breaches of the duty of care) in a series of fiduciary duty cases, beginning with Ryan v. Lyondell Chemical Co., in which the Court of Chancery denied a motion to dismiss a claim that non-conflicted directors breached their duty to act in good faith with respect to a transaction that would provide stockholders with a large premium for their shares. Subsequent cases, including McPadden v. Sidhu, In re Lear Corporation Shareholder Litigation and the Delaware Supreme Court’s reversal of Lyondell, however, made clear that such provisions remain a powerful shield for directors against monetary liability for breaches of the duty of care.

Indemnification Agreements

The Court of Chancery’s decision in Schoon highlighted the role of private indemnification agreements, and in Levy v. HLI Operating Co., the Court of Chancery focused both on the extent to which Section 145(f) of the DGCL may be relied upon in expanding the scope of indemnification and advancement beyond what is expressly set forth in the DGCL and on indemnification in the context of private equity fund designees serving on the board of a portfolio company.

* * * * *

Our article summarizes these developments within the context of the relevant corporate governing documents in order to aid in the review of such documents. We do not intend to conduct an exhaustive analysis on any particular topic or case, but rather to raise awareness of certain interpretive guidelines found within these opinions. Delaware law continues to provide much leeway for private ordering, and awareness of interpretive case law is important in ensuring that a corporation’s governing documents are drafted carefully, have the intended effects and reflect the needs and desires of the corporation.

The article is available here.

(The article is reproduced with permission from Securities Regulation & Law Report, 41 SRLR 921 (May 18, 2009). Copyright 2009 by The Bureau of National Affairs, Inc. (800-372-1033) http://www.bna.com.)

(Editor’s Note: This post comes to us from James McRitchie, Publisher of CorpGov.net.)

Please take a few minutes to read and submit comments on a rulemaking petition that a group of ten filed with the SEC on Friday, May 15th, to amend Rule 14a-4(b)(1). The petition seeks to correct a problem brought to our attention by John Chevedden, long-time shareowner activist. See petition File 4-583 here. Send comments to  rule-comments at sec.gov with File 4-583 in the subject line.

The problem is that when retail shareowners vote but leave items on their proxy blank, those items are routinely voted by their bank or broker as the subject company’s soliciting committee recommends. Current SEC rules grant them discretion to do so. As shareowners who believe in democracy, we have filed suggested amendments to take away that discretionary authority to change blank votes, or non-votes, as they might be termed. We believe that when voting fields are left blank on the proxy by the shareowner, they should be counted as abstentions.

This problem is not the same as “broker voting,” which has already been repealed on “non-routine” matters and, we hope, will soon be repealed for so-called “routine” matters, such as the election of directors. For example, even though “broker voting” has been repealed for shareowner resolutions, if a shareowner votes one item on their proxy and leaves shareowner resolutions blank, unvoted, those blank votes are routinely changed to be voted as recommended by the company’s soliciting committee.

See two examples. At Interface, I voted only to abstain on ratification of the auditors. Yet, you can seeProxyVote automatically fills in my blank votes with votes as recommended by the soliciting committee. A second example, at Staples, shows much the same. You can see blank votes that are changed also include the shareowner proposal to reincorporate to North Dakota, even though such proposals are not considered routine and are not subject to “broker voting.”

Just as broker votes should be eliminated so that votes counted reflect the true sentiment of shareowners, the practice of converting blank votes to votes for management should also end.

In our petition, we also highlight a secondary concern. When shareowners utilizing the ProxyVoteplatform of Broadridge vote at least one item and leave others blank, the subsequent screen warns them that their blank votes well be voted as recommended by the soliciting committee. This provides an opportunity to the shareowner to change their blank vote before final submission, if they don’t want it to be voted as recommended.

…continue reading: Don’t Let Companies Change Shareholders’ Blank Votes

(Editor’s Note: This post is based on a client memorandum by Charles Nathan, Alexander Cohen, Constantine Skarvelis and Raluca Papadima of Latham & Watkins LLP.)

Highlights

• Shareholder proxy access is coming, and it will be the hottest issue of the 2010 proxy season. Public companies should expect, and be prepared for, the strong likelihood of shareholder proxy access in the 2010 proxy season.

• The SEC is scheduled to vote on a proposed shareholder proxy access rule tomorrow, May 20, 2009. We assume that Chairman Schapiro intends the rule to become final around the end of October—that is, in time for the 2010 proxy season.

• Senator Charles Schumer of New York has introduced a bill that, among other things, would confirm the SEC’s authority to adopt a proxy access rule and that would require the SEC to adopt rules directly regulating proxy access, rather than deferring to state law.

• The Delaware General Corporation Law has been amended to authorize companies expressly to adopt bylaws providing for shareholders access to the company’s proxy statement for director nominations.

• Most observers now believe the question is not whether there will be shareholder proxy access for 2010, but rather what it will look like. The shape of proxy access depends principally on whether the final version of the SEC rule:

• For those who accept that shareholder proxy access is a foregone conclusion, the key is the details of how shareholder access will be implemented—the so-called “workability” issues. Workability in the context of proxy access is far more complicated than it may first appear. However, it will be the key to whether proxy access becomes, as many of its supporters assert, a sparingly used device that has the effect of instilling greater accountability of directors or, as many of its opponents fear, the progenitor of countless election contests and divided and dysfunctional boards.

Background

What is Proxy Access?
Shareholder proxy access is a proposed regime that would allow shareholders of a public company to include in a company’s proxy materials (proxy statement and proxy card) candidates for director nominated by the shareholder in opposition to the company’s candidates for election. Under the current regime, only the company’s nominees for election to the board of directors are included in company proxy materials. If a shareholder wants to nominate opposition candidates, it must prepare, pay for and distribute separate proxy materials. The obvious point of shareholder proxy access is to change the classic election contest paradigm and thereby facilitate shareholders’ ability on a virtually costless basis to elect directors who are not on the board slate.

Who are the Players?
There are six main groups of players in the proxy access struggle:

• Corporate governance activists, spearheaded by labor unions, state and local government pension funds and the Council of Institutional Investors, have been the main proponents pushing for proxy access. Although not as vocal, activist investors are also supporters of proxy access;

• The SEC, where Chairman Schapiro has announced that she views proxy access rulemaking as a key priority;

• Members of Congress, such as Senator Schumer and other prominent Democratic lawmakers, seem committed to creating a shareholder access regime of some type;

• The business community, led by the US Chamber of Commerce (the Center for Capital Market Competitiveness) and The Business Roundtable, has been strongly opposed to proxy access since the first SEC rule-making foray in 2003;

• The legal community, through its various bar associations and a number of law firms, will weigh-in on the latest round of the proxy access debate once the SEC issues its proposed rule; and

• The proxy advisory firms, most notably RiskMetrics, which will have a large say on shareholder voting on proxy access proposals and on contested director elections resulting from proxy access, are expected to support proxy access.

…continue reading: The Battle for Shareholder Access: The Current State of Play

(Editor’s Note: This post is based on a client memo from Theodore N. Mirvis, Steven A. Rosenblum, Adam O. Emmerich, David C. Karp, Andrew R. Brownstein, Eric S. Robinson and Trevor S. Norwitz of Wachtell, Lipton, Rosen & Katz.)

Access to company proxy materials for board candidates nominated by shareholders is now an imminent reality. Since the SEC first proposed a shareholder proxy access regime in 2003, the wisdom of such a fundamental departure from traditional practice has been hotly debated. We have long been of the view that shareholder proxy access is a serious mistake, likely to impair the ability of public companies to attract and retain quality directors and lead to a further politicization and balkanization of the boardroom, with attendant negative consequences for American capitalism and competitiveness. (See our comment letters to the SEC in response to the SEC’s 2003 and 2007 proxy access rulemaking proposals.)

Political developments have turned the tide strongly in the other direction. SEC Chairman Schapiro has said that the SEC will consider a shareholder access rule later this month, and Senator Schumer has said that shareholder access will be an element of his so-called “Shareholder Bill of Rights Act of 2009.” In an effort to forestall these attempts to further federalize corporate law, Delaware last month enacted legislation which expressly enables the adoption by Delaware companies of bylaws permitting shareholder access to company proxy materials. Crucially, such bylaws can be adopted not only by a company’s board of directors, but also by shareholder action on shareholder initiative.

Due to the negative impact of shareholder proxy access, we expect that many companies will understandably resist the adoption of shareholder access bylaws of any sort. Others will favor a wait-and-see attitude, particularly since federal legislation or regulation may change the ground rules further. Some companies, however, may wish to consider the preemptive adoption of a reasonable and carefully tailored bylaw, in part to deter, or discourage adoption of, more extreme versions of shareholder access that may be proposed by short-term activist or special-interest shareholders. We have prepared a model shareholder access bylaw (attached) for consideration.

Our model permits shareholders holding at least 5% of a company’s common stock for at least a year to nominate a limited number of independent director candidates using the company’s proxy statement and card. Our model bylaw also contains features designed to prevent the use of shareholder access as a “Trojan Horse” for takeover activity. For shareholders seeking to effect a takeover via director election, the SEC’s existing proxy contest process, containing essential disclosure and procedural safeguards, remains the appropriate mechanism.

The potential variations on the model access bylaw are many, and a board’s decision whether to adopt a shareholder access bylaw at all and, if so, what features it should have, must be carefully considered in the context of each company’s particular situation. For that reason, we believe that if shareholder access is to be a part of our public company landscape, the private-ordering approach through company specific bylaws contemplated by the Delaware legislation is preferable to a federally mandated one-size-fits-all proxy access rule. We expect that significant, long-term shareholders that do not desire the companies in which they invest to be subject to director election free-for-alls – and the risks likely to result – should find that the attached model shareholder access bylaw offers a reasonable framework.

(Editor’s Note: This post comes to us from Matteo Tonello of The Conference Board, Inc. and Damien Park of of Hedge Fund Solutions.)

The Conference Board released an executive action report discussing expected trends in shareholder activism in light of the current economic and political environment. The paper is the fourth in The Conference Board series of papers on the oversight role of the board of directors in the financial crisis. It provides board members with a checklist of issues they should consider addressing in their relations with shareholders and, in particular, how to avoid a costly and disruptive battle with an activist investor.

With corporate valuation declining and an economic and political environment favorable to change, the 2009 proxy season is witnessing a new wave of investor demands. In particular, due to the liquidity problems facing many corporations, there is a clear shift from the financial-oriented activism campaign aiming at cash extractions to new initiatives pursuing strategic, operational, and governance-related corrections.

The paper argues that it is in the interest of corporate boards to act proactively, understand shareholder intentions, and correct vulnerabilities so as to avoid becoming the target of activists. A history of positive relations with shareholders, especially the largest ones, can be the most important asset when an activism campaign is launched or is in course. Following the example of Pfizer—which first announced, in 2007, the practice of inviting representatives of investors to meet regularly with the company’s board—several other companies experimented with forms of direct engagement, including road shows and town hall meetings with directors to discuss one or more issues raised by investors.

In these market circumstances, directors should make an extraordinary effort to test the business strategic viability, improve performance and reduce operational inefficiencies. In particular, The Conference Board recommends that board members, among other things:

The paper also offers practical suggestions on how to design an action plan and respond to negative publicity campaigns mounted by disgruntled investors. Several current examples as well as a detailed table of cases from the 2009 proxy season are included.

Our paper is available here.

(Editor’s Note: This post comes to us from Glenn Curtis, Director of Strategic Research at Thomson Reuters.)

Thomson Reuters has recently released its Strategic Research Report on Shareholder Activism for 2008. The report focuses on activist situations that have taken place from October through December 2008. It also details success and failure rates and other data pertaining to activist situations in 2007 and 2008. The source for this data was Thomson’s SDC Platinum™ database, the SEC, and various press releases.

Highlights from the report include the following:

• For the full year 2008 Information Technology and Consumer Discretionary companies were among the top targets for activist firms. This is consistent with previous research. In fact, Consumer Discretionary companies have been among the top targets for the last two years.

• The average target company in the fourth quarter of 2008 had a market capitalization of just $28.2 million. That was a significant decline from the $4.93 billion that was recorded in the third quarter. A decline in the share prices of the targeted companies may be one reason for the low market cap. However, it is worth noting that the companies that were targeted were smaller cap companies to begin with.

• The most common demands that activists made for the year were for board seats and to buy/sell the target company. Board seats have consistently been a top demand according to our prior research.

• The number of cases where activists were successful in achieving their goals declined from 2007 to 2008, while the number of compromise situations increased. More specifically, for the full year 2008 activists achieved their goals 29% of the time and compromise was reached 38% of the time. In 2007 activists were successful 41% of the time and compromise was reached in 12% of cases.

• Big name activists such as Carl Icahn and Pershing Square and others were notably absent from new activity in the fourth quarter. However, both were active throughout 2008 in several high profile cases.

• If historical patterns hold true, look for an uptick in activism cases in Q1 2009. Companies should be on high alert!

The report is available here.

My firm has published the following memorandum on recently-adopted amendments to the Delaware General Corporation Law.

SUMMARY
The Delaware legislature has enacted a number of amendments to the Delaware General Corporation Law (the “DGCL”) relating to the governance of Delaware corporations. The amendments address current corporate governance issues concerning: (i) proxy access and expense reimbursement; (ii) director indemnification and advancement of expenses; (iii) judicial removal of directors; and (iv) flexibility in setting record dates by providing that the record date for mailing the notice of meeting need not be the same as the record date for determining stockholders entitled to vote. The effective date of the amendments is August 1, 2009.

PROXY ACCESS AND EXPENSE REIMBURSEMENT
The amendments include the addition of two new provisions that relate to permissible bylaw provisions governing proxy contests. The effect of these changes is not to mandate either proxy access or expense reimbursement (unlike North Dakota’s 2007 statute which does so), but rather to provide a list of nonexclusive provisions that might be contained in a bylaw addressing proxy access or proxy solicitation expense reimbursement. As such, the amendments make no change in the Delaware law—properly constructed bylaws containing such provisions would almost certainly have been permissible under Delaware law prior to the adoption of these provisions. Nor do the amendments mandate the restrictions that are suggested—the statute simply provides that a bylaw may contain certain procedures or conditions, and lists a number of potential provisions. Adoption of these provisions does nonetheless clarify that under Delaware law, issuers may impose restrictions on proxy access and proxy expense reimbursement bylaws, which may influence, as a practical or legal matter, any future federal legislation or rule-making on the subject.

New Delaware Provisions on Bylaws Concerning Stockholder Access to Proxy Materials
The amendments include a new Section 112, which states that a corporation’s bylaws may provide that if the corporation solicits proxies with respect to an election of directors, the corporation may be required to include individuals nominated by stockholders, in addition to individuals nominated by the board of directors. The new statute provides that the right of access to the corporation’s proxy materials may be conditioned on a number of factors or procedures, which may include the following:

• Minimum record or beneficial ownership, or duration of ownership, of shares of the corporation’s capital stock. The bylaws may define beneficial ownership to take into account options or other rights in respect of or related to the corporation’s capital stock.

• Submission of specified information concerning the stockholder and the stockholder’s nominees, including information concerning ownership by such persons of shares of the corporation’s capital stock, or options or other rights in respect of or related to such stock.

• Eligibility for inclusion in the proxy materials based on the number or proportion of directors nominated by the stockholder or whether the stockholder previously sought to require access to the corporation’s proxy materials.[1]

• Prohibitions on nominations if the nominating stockholder, the stockholder’s nominee or any affiliate or associate of the nominating stockholder or nominee has acquired, or has publicly proposed to acquire, shares constituting a specified percentage of the voting power of the corporation’s outstanding voting stock within a specified period before the election of directors.

• A requirement that the nominating stockholder undertake to indemnify the corporation for any losses arising as a result of any false or misleading information or statement submitted by the nominating stockholder.

…continue reading: Delaware Adopts DGCL Amendments

(Editor’s note: This post is based on a memorandum By Jim Kroll of Towers Perrin entitled The 2009 Proxy Season: How Will Shareholders Vote on Compensation-Related Proposals in Today’s Contentious Climate?)

With the hammering that many stocks took last fall, and the intensifying scrutiny and criticism of executive pay in financial services and other industries, it’s probably not surprising that the number of compensation-related shareholder proposals appears to be up this proxy season. While it’s far too soon to predict the outcome of this season’s voting, early votes suggest that these proposals may garner as much, if not greater, support in today’s contentious shareholder environment than in past years. How companies respond to this year’s voting also remains to be seen, although it’s likely that many boards will be paying even closer attention to shareholder views than in the recent past as a result of changes in several RiskMetrics Group (RMG) policies related to executive pay.

This article reviews the shareholder proposals filed to date and votes thus far on compensation-related proposals in the current proxy season, along with a look at how RMG policy changes are influencing the shareholder engagement dynamic this year on compensation matters in general.

The Evolving Shareholder Dialogue
Shareholder proposals that address key compensation issues are often viewed as a barometer of investor sentiment regarding executive pay. While the number of compensation-related proposals filed and voted on tends to fluctuate from year to year, the general trend in recent proxy seasons has been toward more shareholder activism on a number of compensation fronts. This is reflected in both the number of proposals filed and in the levels of support they receive from shareholders.

Proposals falling into two general categories — say on pay and pay for performance — have tended to dominate the last three or four proxy seasons. In past years, various labor unions took a lead role in filing such proposals. However, our analysis of the 2009 proxy season finds unions playing a somewhat smaller role this year. For example, say-on-pay proposals, the largest and fastest-growing category, were offered by a wide range of proponents in 2009, including pension funds and other investors. This shift, particularly as it relates to say-on-pay proposals, may be due to the fact that various shareholder groups have been discussing the topic and may be pooling their efforts in order to reach a larger number of companies.

Moreover, the number of pay-for-performance proposals has declined again this year because the leading union proponents are taking a year off from filing such proposals (but may resume filing these proposals next year). These proposals, which include measures to adopt performance-based options, link pay to performance, implement “common sense” compensation and adopt performance- and time-based restricted stock, made up the largest category of shareholder proposals as recently as two years ago. They’ve virtually disappeared from the proxy landscape this season. While shareholder proposals on the topic have declined, the proponents have changed their tactics and are proactively engaging companies in discussions about their pay practices. Other proposals on the decline this year are those addressing golden parachutes, clawbacks and supplemental executive retirement plans (SERPs).

…continue reading: Compensation Proposals in 2009 Proxy Season

The Harvard Law School Program on Corporate Governance recently issued The Elusive Quest for Global Governance Standards, a discussion paper I co-authored with Professor Assaf Hamdani. The paper is scheduled for publication in the University of Pennsylvania Law Review. Our slides from a recent presentation of the paper at the Sloan Foundation corporate governance research conference are available here.

We focus in our paper on the substantial efforts by researchers and shareholder advisers to develop metrics for assessing the governance of public companies around the world. These important and influential efforts, we argue, suffer from a basic shortcoming. The impact of many key governance arrangements depends considerably on companies’ ownership structure: measures that protect outside investors in a company without a controlling shareholder are often irrelevant or even harmful when it comes to investor protection in companies with a controlling shareholder, and vice versa. Consequently, governance metrics that purport to apply to companies regardless of ownership structure are bound to miss the mark with respect to one or both types of firms. In particular, we show that the influential metrics used extensively by scholars and shareholder advisers to assess governance arrangements around the world—the Corporate Governance Quotient (CGQ), the Anti-Director Rights Index, and the Anti-Self-Dealing Index—are inadequate for this purpose.

We argue that, going forward, the quest for global governance standards should be replaced by an effort to develop and implement separate methodologies for assessing governance in companies with and without a controlling shareholder. We also identify the key features that these separate methodologies should include, and discuss how to apply such methodologies in either country-level or firm-level comparisons. Our analysis has wide-ranging implications for corporate-governance research and practice.

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Here is a more detailed description of the paper: There is now widespread recognition that adequate investor protection can substantially affect not only the value of public firms and their performance but also the development of capital markets and the growth of the economy as a whole. This view has naturally led to heightened interest in identifying and bringing about corporate-governance improvements at both firm- and countrywide levels. These developments also have sparked substantial demand for reliable metrics for evaluating the quality of corporate governance in public firms. And both academic researchers and shareholder advisers have made considerable efforts to develop such metrics.

The notion of a single set of criteria to evaluate the governance of firms around the world is undoubtedly appealing. Both investors and public firms are, after all, operating in increasingly integrated global capital markets. Our paper argues, however, that the quest for a single, global governance metric is misguided.

…continue reading: The Elusive Quest For Global Governance Standards

(Editor’s Note: This post comes to us from Eduardo Gallardo, James J. Moloney and James B. O’Grady of Gibson, Dunn & Crutcher LLP.)

On March 30, 2009, the SEC staff issued two no-action letters[1] regarding the solicitation of proxies to vote in the election of directors in a situation where two dissident shareholders had submitted separate “short slates” of director nominees for election at the same annual meeting. The no-action letters permit a soliciting shareholder to “round out” its short slate of directors with the nominees of other dissident shareholders, under an expansive reading of the proviso to the “bona fide nominee” rule in Exchange Act Rule 14a-4(d). Such proviso had historically been interpreted only to permit a soliciting shareholder to “round out” its short slate with nominees of the registrant.

The effect of the no-action letters is to facilitate the ability of shareholders to elect non-incumbent directors in situations where more than one dissident shareholder is running a short slate. The SEC staff conditioned its relief on a number of requirements, including that any such dissidents must not have agreed to, and must have no intention of, forming a “group” as determined under Regulation 13D-G.

Analysis

In recent years it has become increasingly more common for dissident shareholders to run a “short slate” of directors for election at annual meetings – that is, a dissident slate for less than a majority of the registrant’s board of directors. This is becoming the preferred approach for dissidents seeking board representation for two primary reasons. First, proxy advisory firms such as RiskMetrics and large institutional investors have historically proven to be more supportive of short slates than of dissident efforts that seek to replace a majority of the board. Second, running short slates avoids the risk of triggering so-called “poison puts” – provisions in a registrant’s debt documents which would require the registrant to repurchase outstanding debt obligations upon the occurrence of certain defined events, which sometimes include incumbent directors ceasing to constitute a majority of the board.

SEC rules require that each nominee named in a proxy card must be a “bona fide nominee.” Prior to the adoption by the SEC of the shareholder communications rules in 1992, in order to qualify as a “bona fide nominee,” each nominee had to consent to being named in a proxy card. This unqualified requirement effectively prevented a dissident’s proxy card from conferring authority to vote for a registrant’s nominees, because registrant nominees were unlikely to consent to being named on a dissident’s proxy card. The rule placed dissident shareholders running short slates of directors at a disadvantage to registrants – shareholders effectively faced a choice between voting for the registrant’s full slate of nominees, in order to exercise their full voting rights, or voting for a less than full slate of dissident nominees. However, in 1992, the SEC added the so-called “short slate rule” – really an exception to the bona fide nominee rule — which allows a dissident shareholder’s proxy card to “round out” a short slate of nominees by obtaining authority to vote for some of the registrant’s own nominees.

…continue reading: SEC Grants No-Action Relief to Activist Shareholders

This post is by my colleagues Phillip R. Mills and Justine Lee.

The SEC recently published for public comment the NYSE’s proposal to eliminate broker discretionary voting in uncontested director elections, signaling that the Commission’s new leadership is prepared to move forward on an issue that has been on hold at the SEC since it was originally proposed in 2006. The rule change—which would not become effective until 2010 at the earliest—could make it more difficult for companies that have adopted a majority voting standard to elect management’s slate of nominees, as discussed below.

The NYSE has long classified uncontested director elections under Rule 452 as a “routine matter,” giving brokers the discretion to vote shares held in investors’ accounts when they do not receive voting instructions from the beneficial owner within ten days of a company’s meeting. Such uninstructed votes can make up a meaningful percent of the vote and have routinely been cast with management in the past. Several close elections have attracted scrutiny in recent years as activists contended that the outcomes would have been different if broker discretionary votes were excluded. In the absence of SEC action on this issue, a number of brokers have recently moved to voluntary policies of proportional voting, under which they vote uninstructed shares in proportion to how their voting clients cast their ballots. While the proportional voting policy was likely chosen over abstention (which would be closer to the NYSE proposal) in order to address quorum and other concerns, it can also skew voting results by disproportionately magnifying the vote of those retail investors that provide instructions to their brokers—a particular concern in the current climate for embattled companies that may have a dissatisfied retail shareholder base. It can also make outcomes less predictable since, unlike instructed shares, which are cast ten days prior to the meeting, shares voted proportionally are not cast until 72 hours before the meeting.

The NYSE proposal would re-classify director elections as a non-routine matter on which NYSE member organizations are not permitted to vote—regardless of which exchange the company is listed on—without instructions from the beneficial owner. If the SEC adopts the NYSE proposal, brokers would no longer be able to vote uninstructed shares, effectively reducing the number of votes in favor of board-nominated directors. This could make it difficult for directors to attain the requisite majority vote at companies with majority vote standards, particularly if there is a large retail investor base or if directors are facing a “withhold vote” campaign.

The proposed amendment is available here.

(Editor’s Note: This post by Jeremy Goldstein is based on a client memo by Mr. Goldstein and his colleagues Lawrence S. Makow, Jeannemarie O’Brien, Nicholas G. Demmo, and David M. Adlerstein of Wachtell, Lipton, Rosen & Katz.)

The SEC staff has denied a no-action request by Regions Financial to exclude a shareholder proposal requesting that Regions impose numerous restrictions on executive compensation in light of the company’s participation in the TARP Capital Purchase Program (CPP). Several unions have reportedly submitted the proposal (or a variation thereof) at nearly two dozen financial institutions. Its restrictions, if adopted, would severely hamstring a company in designing compensation to attract, retain and incentive senior management. The union proposal would micromanage executive compensation with a laundry list of rigid, inflexible restrictions, including an annual cap on incentive compensation, a requirement of performance vesting for most long-term equity compensation, a requirement that stock option strike prices be peer-indexed, a bar against executives selling more than 25% of their equity awards while they remain employed, a prohibition on accelerated (e.g., non-cause firing) vesting for all executive equity awards, a limit on severance payments to no more than annual salary and a freeze on the accrual of retirement benefits under SERPs.

Regions argued that the proposal is actually multiple proposals in violation of Rule 14a-8 and is vague and indefinite (among other reasons, for failing to say whether the restrictions would be permanent or limited to the period of TARP participation). Regions also argued that it had substantially implemented the proposal by agreeing to limit executive compensation in its CPP investment agreement with the U.S. Treasury. Last December, the SEC staff granted no-action relief to SunTrust on a substantially identical shareholder proposal. In denying Regions’ request for no-action relief, the staff provided no explanation for its about-face.

As described in our memorandum of February 13, 2009, the just-enacted stimulus bill requires Treasury to implement harsh compensation restrictions for TARP participants. Last week, Treasury announced its own distinct set of compensation requirements for prospective TARP participants. Each of these differs from the contractual compensation restrictions that CPP participants believed they were signing up for in round one of the TARP. Right now, directors and managers of financial institutions are being compelled to spend significant time grappling with responses to these developments. In this overheated environment, boards of many major financial companies will now also have to contend with the recent wave of “kitchen sink” shareholder initiatives on executive compensation. The SEC and investors alike would be well served to consider whether a continual ratcheting up of distraction and pressure on financial institutions is the best path to hastening economic recovery and restoring credit markets.

The Millstein Center for Corporate Governance and Performance at the Yale School of Management has recently released a new policy briefing entitled “Voting Integrity: Practices for Investors and the Global Proxy Advisory Industry.”

Accountability of corporate boards to shareowners rests in large part on the integrity of the system by which investors vote their proxy ballots. Shareowners rely on the vote to affect the governance of a company; corporate directors see the vote as a barometer of investor confidence in board stewardship. Outcomes determine the fate of director tenure, mergers, acquisitions, capital raising, remuneration plans and other critical decisions with sometimes profound consequences for stakeholders and the marketplace.

However, this briefing finds that the proxy voting system in the US and other markets is chronically subject to criticism that it is short on integrity sufficient to ensure trust. Parties involved are institutional investors, agents such as proxy advisory services, and intermediaries charged with transmitting ballots. Threats include conflicts of interest, opacity, technical faults in the chain by which ballots are transmitted, and a shortage of resources devoted to informed decision-making.

Remedies proposed in this briefing include:

• Governance firms should endorse and comply with a first industry-wide code of professional ethics, including a general ban on a vote advisor performing consulting work for any company on which it provides voting recommendations or ratings.

• Institutional investors should endorse and follow guidance on their own governance produced by the International Corporate Governance Network.

• Institutional investors should report to clients or beneficiaries at least annually on their voting policies and voting records. Further, such institutions should regularly review voting policies to ensure they are fit for purpose; identify, manage and disclose real or potential conflicts of interest on a regular basis; and determine the level and quality of resources necessary and appropriate to deliver vote recommendations and decisions that are in line with their voting policies.

• The US Securities and Exchange Commission should empanel a high-level independent review aimed at modernizing the US proxy voting system. Regulators should work with counterpart bodies in other markets to supervise the seamless integration of national systems to enable accurate and efficient cross-border voting.

The full briefing can be found here.

My firm has recently published “2009 Insights — Navigating Tumultuous Times,” a compendium of current memoranda on subjects we believe are likely to be of particular importance to directors, senior management and counsel in the coming year. The idea for the compendium was triggered by the difficult financial and business environments in the U.S. and globally as we move into 2009, and the advent of a new administration in Washington. In light of this, we thought there could be some real value in pulling together input from a large number of our practice areas and domestic and international offices to provide, in one place early in 2009, our perspective on the coming year. This perspective encompasses both problem areas, including approaches to dealing with them, and some opportunities.

The individual memoranda are intentionally brief, to facilitate review by business executives and directors — there clearly is much more to be said on virtually every subject. The following outline, from the compendium itself, indicates the breadth of territory covered in the 10 sections of the compendium.

• Capital Markets and Hedge and Private Equity Funds: For many of our clients, the area of most direct interest is how the tumultuous financial environment may impact their capital structure. We emphasize both advance planning and prophylactic measures that are applicable to most entities, whether or not currently under distress. We also examine potential opportunities created by the turmoil in financial markets and the impact on various capital markets sectors.

• Corporate Restructuring: It is generally expected that 2009 will be dominated by a global wave of corporate restructuring activity. We provide information on various techniques that will be of assistance to stressed entities looking to restructure their balance sheets, as well as entities that may seek to acquire or consolidate with a troubled entity.

• Financial Institutions: The events of recent months have led to a series of financial crises and dramatic governmental responses. We examine legislative developments in the US and Europe, provide guidance regarding the current enforcement and litigation landscape, and look ahead to future developments affecting financial institutions.

• Global M&A: A significant amount of recent merger and acquisition activity has focused on restructuring prompted by the demands of governments or creditors. As corporations around the world continue to assess their financial and business environments, new strategic M&A scenarios likely will develop. We include information highlighting current influences on mergers and acquisitions.

• Governance: The financial and economic crises and the response of various governmental bodies, once again, emphasize the importance of proper corporate governance. The range of issues confronting directors and members of management are explored in a series of memoranda that assess trends and offer guidance on those issues, including directors’ duties, executive compensation and financial reporting.

• Governmental, Regulatory and Tax Enforcement: In the US, the EU and elsewhere, shifting governmental priorities in response to various factors, including the economic environment, will impact a wide range of industries. We assess these developments across governmental arenas.

• Intellectual Property and Information Technology: We address a number of areas of interest related to intellectual property — the most valuable asset of the so-called “new economy.”

• Litigation and International Arbitration: We anticipate the upheavals of the last year and a half will continue to result in increased litigation, much of which will be complex and international in nature. We discuss the expected trends and likely strategies for managing such disputes.

• New Markets: Brazil, China, India and Russia are not immune to the global financial and economic crisis, and their status as emerging markets creates unique circumstances for conducting business there. We discuss various issues, trends and laws relevant to business activity in each country.

• Real Estate: In the eye of the economic storm, the real estate industry, including REITs, faces a number of issues, which we discuss here.

The compendium is available here.

Note: Navigating tumultuous times requires keeping up to date. In the brief period since the compendium was issued, there have been significant changes in a number of areas, particularly U.S. economic stimulus legislation, regulation of financial institutions and executive compensation. We continue to monitor the areas covered in the compendium and publish memoranda addressing significant developments.

This post is by my partners Michael Tumas and John Grossbauer.

The Council of the Corporation Law Section of the Delaware State Bar Association earlier today forwarded to Corporation Law Section members the proposed 2009 amendments to the Delaware General Corporation Law (“DGCL”). Consistent with Delaware’s preference for enabling legislation and maintaining maximum flexibility, the amendments eschew mandates for corporate action. Specifically, the proposed amendments create new Sections 112 and 113 that expressly permit Delaware corporations to adopt bylaws implementing proxy access and requiring reimbursement of stockholder proxy expenses in certain circumstances. Also included among the proposed amendments are changes to Section 213, to permit Delaware corporations to provide separate record dates for determining stockholders entitled to notice of and to vote at stockholder meetings, a new provision permitting judicial removal of directors in extreme, emergency circumstances, and a revision to Section 145(f) expressly providing that pre-existing indemnification and advancement rights provided in a corporation’s governing documents cannot be impaired by later amendments to those documents. The amendments are summarized in more detail below.

Access to Proxy Solicitation Materials (New Section 112)
The proposed amendments create a new section of the DGCL, Section 112, expressly authorizing a Delaware corporation to adopt a bylaw that grants stockholders the right to include within the corporation’s proxy solicitation materials stockholders’ nominees for the election of directors, subject to any lawful conditions the bylaws may impose. The subject of “proxy access” had been a significant one, and it promised to continue to be so in the current environment. The addition of proposed Section 112 removes any uncertainty regarding the ability of Delaware corporations to effect proxy access through adoption of a bylaw. In so doing, the proposed amendment clarifies that corporations may impose reasonable restrictions on the stockholders’ right to access company proxy materials and identifies a non-exclusive list of restrictions that are deemed to be reasonable.

One condition specified in Section 112 would permit the bylaws to establish minimum ownership requirements for stockholders to become eligible to include nominees in company proxy materials, measured both by amount and duration of ownership. The bylaws may establish this minimum ownership threshold by defining beneficial ownership to include ownership of options or other rights relating to stock, including derivative rights. Because Section 112 is intended to apply to stockholder nominations of short slates of directors and not as a vehicle for effecting changes of control through the corporation’s own proxy materials, the new section also expressly permits the bylaws to condition eligibility for inclusion in the corporation’s proxy materials to nominations for a limited number of seats that may be contested and to preclude entirely inclusion of nominations by persons who own or propose to acquire (such as through a tender offer) more than a specified percentage of the corporation’s stock. The bylaws also may require the nominating stockholder to submit specified information such as information concerning the ownership of the corporation’s stock by the stockholder and the stockholder’s nominees. The bylaws also may condition eligibility to require inclusion of nominees in the corporation’s proxy materials on the nominating stockholder’s execution of an undertaking to indemnify the corporation for any loss resulting from any false or misleading information submitted by the stockholder and included in such proxy materials, or on “any other lawful condition.”

…continue reading: Amendments to the Delaware Corporation Code

This post is by my colleagues Beverly Fanger Chase, Ning Chiu, Edmond T. FitzGerald, Kyoko Takahashi Lin, Jean M. McLoughlin, and Barbara Nims.

Media and public attention surrounding the American Recovery and Reinvestment Act of 2009, enacted on February 17, 2009 and commonly referred to as the stimulus bill, has typically focused on the law’s restrictions on the amounts and forms of compensation payable to executives of TARP participants.[1] An important provision of the stimulus bill that has not as yet received much notice, but is now a reality for all institutions that receive or have received government assistance under TARP, is the requirement that such institutions permit their shareholders to vote on executive compensation – a so-called “say on pay” vote.

Shareholder proposals advocating for say on pay have been a recent priority item on shareholders’ governance agenda, with reports indicating that as many as 100 proposals have been submitted to public companies for the 2009 season. Support for the approximately 70 proposals submitted to shareholders in the 2008 season averaged approximately 42%, with ten proposals reported as receiving majority support from shareholders. Although say on pay has not been widely adopted by companies, 18 companies to date have agreed to institute company proposals seeking a say on pay vote in their proxy statements. Six of these companies have already included such a company proposal in their proxy statements, with shareholder support for the companies’ executive compensation ranging from 62.5% to 98.7%.

The new SEC leadership has publicly expressed its support of adopting say on pay for all companies outside the context of the stimulus bill. Mary Schapiro, Chairman of the SEC, stated in a recent speech that “giving shareholders a greater say on . . . how company executives are paid” is on the SEC’s agenda. Further, SEC Commissioner Elisse B. Walter in recent remarks stated that she believes say on pay can help restore investor trust, and she encouraged more companies to voluntarily adopt say on pay.

Stimulus Bill Requires Say on Pay, But Timing of Implementation Originally Unclear
The stimulus bill requires that the shareholders of any institution that has received or will receive financial assistance under TARP be provided with an annual non-binding say on pay vote on executive compensation each year during the period in which any obligation arising from such financial assistance remains outstanding. In its annual meeting proxy statement, each institution must provide a separate shareholder vote to approve the compensation of the institution’s executives as disclosed pursuant to the SEC’s compensation disclosure rules, which include the compensation discussion and analysis, the compensation tables and related narrative.

The stimulus bill called for the SEC to issue final regulations regarding this say on pay provision within one year after the date of the bill’s enactment. The legislation did not indicate whether the say on pay provision was effective immediately upon its enactment, or would only become effective after the SEC issued these regulations.

The stimulus bill also makes clear that this shareholder vote is not intended to be binding upon an institution’s board of directors and may not be construed as overruling any board decision, nor does it create or imply any additional fiduciary duty of the board.

…continue reading: “Say on Pay” Now a Reality for TARP Participants

This month’s issue of The Review of Financial Studies features our article, “What Matters in Corporate Governance?.”

The article investigates the relative importance of the 24 provisions followed by the Investor Responsibility Research Center (IRRC) and puts forward an entrenchment index based on six provisions: staggered boards, limits to shareholder bylaw amendments, poison pills, golden parachutes, and supermajority requirements for mergers and charter amendments. The article shows that increases in the index level are monotonically associated with economically significant reductions in firm valuation as well as large negative abnormal returns during our period of examination. The other eighteen IRRC provisions not in our entrenchment index were uncorrelated with either reduced firm valuation or negative abnormal returns.

Since the initial version of our study was first circulated in the fall of 2004, many researchers have used the entrenchment index we put forward. A list of over 75 studies using the index is available here. For those who might wish to use the entrenchment in subsequent research, data on firms’ entrenchment index levels during the period 1990-2007 is available here.

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Below we describe the article’s results and contributions: There is now widespread recognition, as well as growing empirical evidence, that corporate governance arrangements can substantially affect shareholders. But which provisions, among the many provisions firms have and outside observers follow, are the ones that play a key role in the link between corporate governance and firm value? This is the question on which our article focuses.

…continue reading: What Matters in Corporate Governance?

Last week, on behalf of sixty corporate and securities law professors from thirty-eight law schools around the country, I filed an amici curiae brief in the case of Lucian Bebchuk vs. Electronic Arts, Inc.. The case is  now pending before the United States Appeals Court for the Second Circuit. The professors’ amici curiae brief is available here, and the names of the professors joining the brief are listed at the bottom of this post.

The case focuses on a shareholder proposal that was submitted by Lucian Bebchuk to Electronic Arts (EA). The proposal is precatory and recommends that the board submit to a shareholder vote a charter or bylaw amendment that, if adopted, would require the company (to the extent permitted by law) to include in the company’s proxy materials qualified proposals for a bylaw amendment. For a proposal to be qualified, the proposal would have to meet certain significant requirements, including being submitted by a shareholder(s) with more than 5% of the company’s stock. The proposal is available here.

EA excluded the proposal from the company’s ballot, and the case focuses on whether the SEC’s shareholder proposal rule (Rule 14a-8) allows the company to do so.

The case comes before Second Circuit on appeal from the District Court for the southern District of New York. The District Court accepted the position of EA in a brief bench ruling and sent the case to the Second Circuit. The transcript of the District Court’s hearing is available here. The opening brief filed in the appeal by Lucian Bebchuk’s counsel, Grant & Eisenhofer, is available here. A sense of the position that EA can be expected to present in the appeal can be obtained from the opening brief and reply brief EA submitted to the District Court, which are available here and here, as well as from the amicus curiae brief, available here, submitted to the District Court by the Chamber of Commerce.

The professors’ amici curiae brief, filed in support of the appellant’s position, focuses on two central arguments made by EA in defense of excluding the proposal:

(1) Inconsistency with the Proxy Rules Argument:

In its bench ruling, the District Court, accepting the position of EA and the Chamber, held that EA may omit the proposal as inconsistent with Rule 14a-8. The District Court viewed any provision in the certificate of incorporation or the bylaws that would limit the discretion of EA’s directors to control access to the issuer’s proxy statement as inconsistent with Rule 14a-8. The District Court held that Rule 14a-8 mandates that the discretion it provides to companies to omit certain proposals be exercised fully and solely by the company’s board. The Court stated that “it is clear… that the SEC understand[s] the company to be those who act for the company … And that is a small, relatively small group of people, like the board of directors, who have management discretion to run the business and affairs of the company. And it is they that must have this discretion.”

…continue reading: Electronic Arts Before the Second Circuit: The Amici Curiae Brief of 60 Corporate and Securities Law Professors

In my paper Would Changes in the Rules for Director Selection and Liability Help Public Companies Gain Some of Private Equity’s Advantages?, to be published in Volume 76 of the University of Chicago Law Review, I examine whether changes in existing legal rules governing how public company directors are chosen and the extent to which public company directors can be held liable for damages if they do not have a conflict of interest would be likely to increase the ability of public companies to obtain some of the benefits that companies owned by private-equity sponsors appear to have. It is widely believed that companies owned by private-equity sponsors have significant advantages over public companies. Among the advantages of private equity cited by commentators are: (1) better governance and a greater willingness to take risks, (2) the ability to focus on long-term issues and a more stable shareholder base, (3) the ability to attract better management talent, (4) creating a sense of urgency, (5) the ability to use leverage more effectively, (6) avoiding the costs imposed by the Sarbanes-Oxley Act, and (7) freedom from shareholder suits. It would be helpful if public companies could gain some of these advantages. My conclusion is that, while changing the rules for selecting directors would not be worthwhile, a reduction in the potential liability of directors for damages in situations in which they do not have a conflict of interest would be likely to increase the ability of public company companies to mirror the effectiveness of private-equity portfolio companies without creating other problems that would be unacceptable.

The paper is available here.

(Editor’s Note: Previous posts on this blog concerning RiskMetric Group’s policy updates are available here and here.)

My colleague Laura A. McIntosh and I (with help from our colleague David Adlerstein) wrote an article entitled “RiskMetrics Update Continues to Hamper Director Discretion,” which discusses the 2009 updates to the domestic and international corporate governance policies of RiskMetrics Group (formerly know as ISS). RMG’s policy updates continue its trend of espousing policies that tend to shift corporate decision-making from boards of directors to shareholders, including activists and special interest groups. In particular, RMG’s updated policies seek to further limit directors’ discretion in areas traditionally within the board of directors’ clear authority under state law, including executive compensation, corporate governance matters and social policy.‬‪ ‬‪ As an example, RMG has revised its policy with respect to management proposals to ratify a shareholder rights plan. In addition to considering whether a shareholder rights plan includes RMG’s prescribed attributes (such as a 20 percent or higher triggering threshold and a shareholder redemption feature), RMG also will take into consideration a company’s existing governance structure, including board independence, existing takeover defenses and “any problematic governance concerns.” In the face of these new, subjective criteria, it remains to be seen in what circumstances RMG would, in fact, recommend in favor of adopting a shareholder rights plan. Importantly, RMG is continuing its policy of recommending “withhold votes” against an entire board of directors, if the board adopts or renews a rights plan without shareholder approval, does not commit to putting the rights plan to a shareholder vote within one year of adoption, or reneges on a commitment to put the rights plan to a vote and has not yet received a “withhold vote” recommendation for this issue. The article explains why we believe this policy update could be problematic for corporations in the current troubled market environment.‬ ‪ ‬‪

The article is available here.

Less than two decades after Francis Fukuyama famously enshrined market-based liberal democracy as an optimal system at “the end of history,” [1] Barack Obama used his inaugural address to warn the nation that, “without a watchful eye, the market can spin out of control.” The change in tenor from capitalist triumphalism to our current trepidation is indeed remarkable.

In these somber days, with corporate failures still grabbing headlines, the new President has inherited not only a severely weakened economy, but also executive leadership of a government that has already committed hundreds of billions of dollars recapitalizing the financial sector. With so much taxpayer money on the line, additional bailout requests piling up across the corporate landscape, and public anger still cresting, little wonder that the debate is now broadening to what kind of owner government should be. Will the large federal stake in banking, auto, and perhaps other industries prove blessing or burden? Onus or opportunity?

In fact, President Obama has signaled that he doesn’t have much taste for his government’s actively managing corporations. Immediately before his inaugural warning about the failures of unchecked capitalism, the President sounded almost Fukuyama-esque himself in declaring that there remains no question about the market’s unmatched “power to generate wealth and expand freedom.”

How then is the new administration to find a productive — but not meddlesome — federal role that neither relinquishes authority nor shirks its new responsibility as a major stakeholder? Finding such a position relies, I contend, on understanding the crucial role of corporate ownership in America’s economic system: how it should ideally function, how it has actually existed, and what can be done to encourage its more perfect realization.

My article is available here.

[1] Francis Fukuyama, Summer 1989, The National Interest - “The struggle between two opposing systems is no longer a determining tendency of the present-day era. At the modern stage, the ability to build up material wealth at an accelerated rate on the basis of front-ranking science and high-level techniques and technology, and to distribute it fairly, and through joint efforts to restore and protect the resources necessary for mankind’s survival acquires decisive importance.”
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(This post comes to us from Ted Wallace of the Altman Group. It recently appeared in The Corporate Counsel.)

A Special Purpose Acquisition Company (SPAC) is a publicly traded shell (or blank check) company formed for the specific purpose of buying an existing company, usually in a particular industry.

At the IPO, investors purchase units of the SPAC, consisting of a combination of shares and warrants, at a relatively low price. The SPAC then generally has 24 months to find a suitable company to purchase through a reverse-merger.

So how would a hedge fund become the target of hedge fund activism? Ask TM Entertainment & Media, Inc. (AMEX: TMI). This SPAC must complete an acquisition before October 17, 2009 or its “corporate existence will cease by operation of law” and its funds and assets will be distributed among its shareholders. This, however, is apparently too long to wait for Phil Goldstein of Bulldog Investors.

On December 17th, Goldstein (d/b/a Opportunity Partners LP) filed preliminary proxy materials to commence a consent solicitation to replace the board of directors with his nominees, who will “promptly dissolve the issuer and cause the cash in the trust account to be distributed to shareholders.”

…continue reading: Hedge Fund Activism Extends to SPACs

(Editor’s Note: This post is based on a client memo by partners at Cravath, Swaine & Moore LLP.)

The outlook for proxy season 2009
This proxy season will be significantly affected by the credit crisis and the ensuing global economic turmoil. Investors and politicians have joined in an outcry over a perception of excessive executive pay, reckless risk-taking by management and inadequate board oversight at some companies. Prosecutors have launched investigations at numerous financial institutions, perceived abuses have been widely reported in the media, and Congress is seeking to reform compensation practices and give shareholders the right to vote on executive compensation.

Management and boards will be well-served at this time to reassess their compensation and governance policies and practices, as well as how they communicate with their investors. A strategic and well-analyzed response by a company and its board to these unprecedented conditions will be crucial to managing this challenging proxy season successfully.

Prepare for investor and regulatory scrutiny of executive compensation
Compensation practices undoubtedly will be an area of sharp focus this proxy season. The number and variety of shareholder proposals addressing compensation practices and policies is increasing. In particular, we are seeing an increase in proposals related to “say on pay,” “pay for performance,” “clawback” of executive pay in the event of a financial restatement and elimination of a variety of “poor pay practices” (e.g., tax gross-ups on executive perks or excise payments triggered by golden parachute payments and payment of dividend equivalents on unearned performance awards). Variations of each of these proposals have been endorsed by proxy advisor RiskMetrics (formerly ISS), an influential source of voting advice for institutional investors. RiskMetrics has also aligned its position on compensation policies and proposals for all public companies with the standards set for institutions selling equity to the federal government under the Emergency Economic Stabilization Act (“EESA”). The EESA requires, among other things, that financial institutions receiving assistance under it agree to stringent limitations on executive compensation.

…continue reading: Proxy Season 2009

Over the past year and a half, a perfect storm of economic conditions has triggered an extraordinary downward spiral: the subprime meltdown, liquidity crises, extreme market volatility, controversial government bailouts, consolidations of major banking institutions and widespread economic turmoil both domestically and abroad. Many corporations now find themselves in uncharted territory, with a new paradigm of unpredictability trumping formerly reasonable expectations. In the coming year, boards of directors will need to respond to the challenges and pressures of this new environment. This may include reassessing their agendas, committee structures, time commitments and director recruiting, as well as their role in monitoring performance, compliance and risk management. At the same time, boards need to maintain the collegiality and culture of a common enterprise with the CEO and senior management. In short, the task for boards is not simply to go into crisis mode in order to deal with current issues, but rather to take a more holistic, long-term approach to reassessing their proper role and functioning.

In reviewing their monitoring and oversight roles, boards should be mindful of the shifting legal and regulatory landscape. Although the standard for director liability established in Delaware by the Caremark case accords directors considerable deference in fulfilling their oversight duties, there is a distinct possibility that this level of deference could end up being modified in light of the current economic crisis. The spate of litigation generated by the market turmoil will intensify the scrutiny of some boards and will provide courts with repeated occasions to consider second-guessing board decisions. Various regulators have been focused on risk management policies, some of which have found their way into new federal legislation, and numerous new guidelines and “best practices” purport to raise the bar. As financial losses accumulate, shareholders and the public at large will seek to hold boards and management accountable, and there will be tremendous pressure on corporations to demonstrate that they are responding to the current challenges.

While it is clear that there will be a regulatory response to the economic crisis, the contours and extent of the reforms are still evolving. To the extent that boards can be proactive in addressing new challenges and mitigating risks, there may be some window of opportunity for them to help shape the regulatory response, and steer it toward pragmatic measures that will promote rather than impede the creation of long-term shareholder value.

This memorandum, which I have prepared with my colleagues Steven A. Rosenblum and Karessa L. Cain, sets forth some of the significant issues that boards of directors face in the coming year, as well as some practical considerations to bear in mind. In order to avoid an overemphasis on process and at the same time effectively discharge the board’s duties to appropriately monitor and supervise the business of the corporation, it is necessary to identify the matters meriting the board’s focus and create a reasonable program to deal with them. Some are perennial themes that remain relevant and deserve to be reemphasized from year to year, whereas others have come into particular focus in recent years. It is important to note, however, that “one size does not fit all.” The board of each corporation can and should focus on its own particular issues and tailor procedures to its own circumstances.

The memorandum is available here.

(Editor’s Note: This post comes from Alex Edmans at the Wharton School, University of Pennsylvania.)

In my paper Blockholder Trading, Market Efficiency, and Managerial Myopia which was recently accepted for publication in the Journal of Finance, I analyze how outside blockholders can induce managers to undertake efficient real investment through their informed trading of the firm’s shares.

The model developed in this paper addresses two broad issues. First, it shows that blockholders can mitigate managerial myopia. Small shareholders base their decisions on freely-available short-term earnings. By contrast, a blockholder’s large stake gives her strong incentives to gather costly information about the firm’s fundamental value, i.e., to learn whether weak earnings result from low firm quality or desirable long-term investment. By trading on this information, she causes prices to more closely reflect fundamental value rather than short-term earnings. This increased market efficiency improves real efficiency: the manager is willing to undertake investments that boost fundamental value even if they depress short-term earnings.

This beneficial effect of liquid trading on investment contrasts with conventional wisdom. In the 1980s and 1990s, many commentators feared that the U.S.’s liquid markets would lead to it being overtaken by Japan in international competition, because short-term trading by shareholders causes managers to focus excessively on short-term earnings. They argued that reducing liquidity would make “exit” more difficult upon short-term losses, and force a shareholder to exhibit “loyalty”. My model shows that the mutual exclusivity of loyalty and exit paradoxically leads to complementarities between them. If a blockholder has retained her stake despite low earnings, this is a particularly positive indicator of fundamental value if she could have easily sold instead. In short, the power of loyalty relies on the threat of exit. Far from exacerbating myopia, the liquidity of the U.S. capital allocation system may be a strength, because liquid trading causes prices to more closely reflect fundamental value.

The second issue that the model demonstrates is that shareholders can exert governance even if they cannot intervene directly in a firm’s operations. Most existing theories assume that blockholders govern through “voice” – firing a shirking manager or overturning a pet project. However, intervention is uncommon in the U.S., because blockholders are typically small and face significant legal and institutional barriers. Existing models therefore have difficulty in explaining the role that small blockholders with few control rights play in corporate governance, and thus why they are so prevalent. This paper shows that blockholders can still add significant value even if they lack control.

The paper closes with empirical implications. One set concerns stock-price effects, and is unique to a model where blockholders trade rather than intervene. While block size does not matter in standard microstructure theories, here it is positively correlated with an investor’s private information, trading profits and price efficiency. More generally, the model suggests a different way of thinking about blockholders that can give rise to new directions for empirical research. Previous studies have been primarily motivated by perceptions of blockholders as controlling entities, but new research questions may be motivated by conceptualizing them as informed traders. A second set relates to real effects: blockholders should increase firm investment and deter earnings manipulation.

The full paper is available for download here.

In another paper, co-written with Gustavo Manso, I extend the analysis to consider the role of multiple blockholders, which we observe frequently in practice. We find that splitting a block can be beneficial for corporate governance. While splitting a block weakens “voice”, by creating free-rider problems in intervention, it strengthens “exit” because multiple blockholders trade aggressively, impounding more information into prices. The paper entitled Governance Through Exit and Voice: A Theory of Multiple Blockholders is available for download here.

(Editor’s Note: This post comes from Ronald Masulis at the Owen Graduate School of Management, Vanderbilt University, Cong Wang at the Faculty of Business Administration, Chinese University of Hong Kong, and Fei Xie at the School of Management, George Mason University.)

In our paper Agency Problems at Dual-Class Companies, which was recently accepted for publication in the Journal of Finance, we use a sample of U.S. dual-class companies over the period 1994-2002 to examine how the divergence between insider voting rights and cash-flow rights affects managerial extraction of private benefits of control. Using both a ratio and a wedge measure to capture the voting-cash flow rights divergence, we find four distinctive sets of evidence supporting the hypothesis that managers with greater control rights in excess of cash-flow rights are more likely to pursue private benefits at the expense of outside shareholders.

First, we examine how control-cash flow rights divergence impacts a firm’s efficiency in utilizing an important corporate resource - cash reserves. We find that the marginal value of cash is decreasing in the divergence between insider voting rights and cash-flow rights, which is consistent with the argument that shareholders anticipate that corporate cash holdings are more likely to be misused at companies where insider voting rights are disproportionately greater than cash-flow rights, and therefore place a lower value on these highly fungible corporate assets.

Second, we analyze how the insider control-cash flow rights divergence affects the level of CEO compensation, and find that, ceteris paribus, excess CEO pay is significantly higher at companies with a wider divergence between insider voting and cash-flow rights.

Third, we evaluate the acquisition decisions made by dual-class companies, and find in a multivariate regression framework that as insider control-cash flow rights divergence widens, acquiring companies experience lower announcement-period abnormal stock returns, are more likely to experience negative announcement-period abnormal stock returns, and are less likely to withdraw acquisitions that the stock market perceives as shareholder value destroying. These results suggest that as insiders control more voting rights relative to cash-flow rights, they are more likely to make shareholder value-destroying acquisitions that benefit themselves.

Finally, we examine firms’ capital expenditure decisions as another channel of empire building and private benefits extraction. We find that ceteris paribus, capital expenditures contribute significantly less to shareholder value at firms with a greater divergence between insider voting rights and cash flow rights, suggesting that managers at these companies are more likely to make large capital investments to advance their own interests.

Overall, our results shed direct light on the issue of how insider control-cash flow rights divergence leads to lower shareholder value. In addition, our results further our understanding of why superior-voting shares command a premium in the marketplace over inferior-voting shares.

The full paper is available for download here.

This post is by my colleague Ning Chiu.

The 2009 US proxy season has its unofficial kickoff in the form of RiskMetric Group’s US Corporate Governance Policy Update, where the focus is again largely on executive compensation practices. The Policy Update includes voting recommendations on key issues such as “poor pay practices” and several major governance proposals, including separation of CEO and Chair positions. RMG has also changed its evaluation of total shareholder return in acknowledgement of the volatile market environment. While the season is just beginning, we’ve already spotted several emerging trends, indicating that companies will continue to be targeted by activists even while they may be struggling with their business operations, all of which should make for a very interesting upcoming season. Our memo, which discusses the emerging trends for the forthcoming proxy season as well as RMG’s Policy Update, is available here.