Avoiding Hanging Chads in Corporate Voting in 2024

Paul Washington is Executive Director of the ESG Center at the Conference Board and Chair of the Independent Steering Committee of Broadridge. This post is based on his Broadridge memorandum. Related research from the Program on Corporate Governance includes Universal Proxies (discussed on the Forum here) by Scott Hirst; Does Shareholder Proxy Access Improve Firm Value? Evidence from the Business Roundtable Challenge (discussed on the Forum here) by Bo Becker, Daniel Bergstresser, and Guhan Subramanian; and Private Ordering and the Proxy Access Debate (discussed on the Forum here) by Lucian A. Bebchuk and Scott Hirst.

Executive Summary

In recent years, the U.S. Securities and Exchange Commission (“SEC”) and industry service providers have made significant changes and improvements in processing and reporting proxy votes. The SEC provided new rules for use of universal proxy cards (“UPC”) for proxy fights (“contested solicitations”) and industry initiatives have led to reconciliation of ‘voting entitlements’ well in advance of shareholder meetings and confirmations to shareholders that their votes are reported as cast.

As described in more detail below, systems for processing and reporting votes of shares held “beneficially” in accounts at custodian banks and broker-dealers, are accurate, transparent, and fair. This is critical: When it comes to the largest proxy contests, the votes of beneficial shareholders can represent upwards of 95% of the total shares voted. In most contests, the outcome is known at the close of the polls.

However, when it comes to the remaining 5% of the votes, those held in “registered” form directly on the books of companies (or their transfer agents), the process is largely manual and opaque. Opposing sides count their own votes without providing the daily status reports that all sides receive for votes of beneficial shareholders. Therefore, in the closest cases, final tabulations by election inspectors can be delayed for weeks while attorneys for each side examine the votes of registered shareholders in a “snake pit.” Moreover, in contrast to systems for processing beneficial shares, there are no independent audits of the process or votes by an internationally recognized certified public accountant firm.

When it comes to further improving the U.S. proxy system overall, the “last mile” involves looking at how registered shareholder votes are processed, reported, and audited, and how they can be confirmed on an “end-to-end” basis to shareholders.

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The Holding Foreign Companies Accountable (HFCA) Act: A Critique

Jesse M. Fried is the Dane Professor of Law at Harvard Law School, and Tamar Groswald Ozery is a legal sinologist and Assistant Professor at the Hebrew University of Jerusalem. This post is based on their paper forthcoming in the Harvard Business Law Review. Related research from the Program on Corporate Governance includes Alibaba: A Case Study of Synthetic Control (discussed on the Forum here) by Jesse M. Fried and Ehud Kamar.

Several hundred Chinese companies with a total market capitalization of approximately $1 trillion are listed on U.S. exchanges. Until recently, China prevented the Public Company Accounting Oversight Board from inspecting the China-based auditors of these firms, as required by the 2002 Sarbanes-Oxley Act. In late 2020, then-President Donald Trump signed into law the Holding Foreign Companies Accountable Act which, as amended, requires the delisting of any firm whose auditors cannot be inspected by the PCAOB for two years in a row (the delisting rule).  In addition, the Act requires any China-based firm whose auditor cannot be inspected by the PCAOB to submit documentation and make certain disclosures related to their ties to the Chinese government and the Chinese Communist Party (the disclosure rules). In 2022, China began allowing PCAOB inspections, averting (at least for now) mass delistings.

In a recent paper, The Holding Foreign Companies Accountable (HFCA) Act: A Critique, we argue that the effect of the HFCA Act on U.S. investors is likely to be negative.  While China-based firms do pose unique risks to U.S. investors, the Act fails to mitigate—and may well exacerbate—these risks.

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Chancery Rejects Validity of “New Wave” Stockholder Agreement Terms

Iliana Ongun, Neil Whoriskey, and Dean Sattler are Partners at Milbank LLP. This post is based on a Milbank memorandum by Ms. Ongun, Mr. Whoriskey, Mr. Sattler, Scott Golenbock, Ben Fidler, and Marc Kilani and is part of the Delaware law series; links to other posts in the series are available here.

Summary

Founders and controlling stockholders often seek to retain control over their companies even after taking them public, typically via high-vote share classes or, as was at issue in this case, via stockholder agreements granting the pre-IPO owners broad governance rights.

In West Palm Beach Firefighters’ Pension Fund v. Moelis & Company, the Delaware Court of Chancery recently held that a “new wave” stockholder agreement between Moelis & Company (the “Company”) and its founder, CEO, and board chairman, Ken Moelis was invalid under Section 141(a) of the Delaware General Corporation Law (the “DGCL”) because it contained “pre-approval rights” over a number of corporate actions, required the board to recommend individuals designated by Moelis for a majority of directorships and fill committee positions and board vacancies with Moelis designees, impermissibly constraining the board’s ability to manage the business and affairs of the company—powers the statute does not allow the board to delegate via contract.[1]

Moelis is a strong reminder that the foundation of the corporate form in Delaware is the independent authority of a board of directors, elected by stockholders and entrusted to manage the business and affairs of the corporation as fiduciaries. Delaware will not permit this foundation to be eroded through contractual arrangements with stockholders.

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After 1576 days, DC District Court holds proxy advisor rule invalid

Cydney Posner is Special Counsel at Cooley LLP. This post is based on her Cooley memorandum.

A Federal District Court has just held invalid the SEC’s rule regarding proxy advisory firms. The case dates back to 2019(!), when ISS sued the SEC and then-SEC Chair Jay Clayton in connection with the SEC’s interpretive guidance that proxy advisory firms’ vote recommendations were, in the view of the SEC, “solicitations” under the proxy rules and subject to the anti-fraud provisions of Rule 14a-9.  (See this PubCo post.) Rules confirming that interpretation were adopted in 2020. In its amended complaint, ISS contended that the interpretation in the release and the subsequent rules were unlawful for a number of reasons, including that the SEC’s determination that providing proxy advice is a “solicitation” is contrary to law, that the SEC failed to comply with the Administrative Procedure Act and that the views expressed in the release were arbitrary and capricious. Now, after 1576 days, the DC District Court has agreed, holding that the “SEC acted contrary to law and in excess of statutory authority when it amended the proxy rules’ definition of ‘solicit’ and ‘solicitation’ to include proxy voting advice for a fee.”

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Structure for SPACs: SEC Publishes Final Rules

Mark Brod, Joe Kaufman and Rajib Chanda are Partners at Simpson Thacher & Bartlett LLP. This post is based on a Simpson Thacher memorandum by Mr. Brod, Mr. Kaufman, Mr. Chanda, Partner John Ericson, Counsel Jamie Hahn, and Associate Arielle Katzman. Related research from the Program on Corporate Governance includes SPAC Law and Myths (discussed on the Forum here) by John C. Coates, IV.

Overview

On January 24, 2024, the U.S. Securities and Exchange Commission (SEC) published its much anticipated rules to regulate initial public offerings (IPOs) by special purpose acquisition companies (SPACs) and subsequent business combination transactions between SPACs and target companies (de-SPAC transactions). The SEC issued the nearly 600-page release just prior to the second anniversary of their issuance of the related proposed rules, which we discussed in our prior memo. In that interim period, the volume of SPAC IPOs and de-SPAC transactions have declined meaningfully for a variety of reasons. Market practice related to SPACs also continued to evolve in response to financial market developments, SEC Staff comments on SPAC SEC filings, Staff statements on accounting and disclosure matters, new Staff guidance in the form of Compliance and Disclosure Interpretations (C&DIs), judicial jurisprudence and, significantly, regulatory uncertainty surrounding the matters covered in the proposed rule. The SEC adopted most of the rules proposed in 2022 with some modification, but decided not to adopt its proposed rules regarding underwriter liability or a safe harbor from the definition of “investment company” under Section 3(a)(1)(A) of the Investment Company Act of 1940, as amended (1940 Act), opting instead to issue informal guidance on these topics in the text of the adopting release.

In the SEC’s announcement of the new rules, SEC Chair Gary Gensler underscored the objective of enhanced investor protection and articulated a three-prong approach covering disclosure, the use of projections by issuers and issuer obligations. Beyond a new formal definition of a “Special Purpose Acquisition Company (SPAC),[1]” the final rules, which go into effect 125 days after publication in the Federal Register,[2] focus on the following topics:

  • better alignment of the SEC’s treatment of projections in de-SPAC transactions with those issued in traditional IPOs under the Private Securities Litigation Reform Act of 1995 (PSLRA);
  • additional disclosures about SPAC sponsor compensation, conflicts of interest, shareholder dilution, the target company and other information that the SEC believes is material to investors in SPAC IPOs and de-SPAC transactions;
  • target company status as a co-registrant on any registration statement filed in connection with a de-SPAC transaction (and the related assumption of potential liability under federal securities laws for the disclosures in that registration statement); and
  • a deemed sale of securities by the target company to the reporting shell company’s shareholders in any business combination transaction involving a reporting shell company and a minimum 20-calendar day dissemination period for a SPAC to solicit proxies from its shareholders.

Set forth below is a summary of each of these key aspects of the proposal, along with considerations and potential implications.

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Earnings News and Over-the-Counter Markets

Stefan J. Huber is an Assistant Professor of Accounting at Rice University, Chongho Kim is an Assistant Professor of Accounting at Seoul National University, and Edward M. Watts is an Assistant Professor of Accounting at the Yale School of Management. This post is based on their article forthcoming in the Journal of Accounting Research. Related research from the Program on Corporate Governance includes Big Three Power, and Why it Matters (discussed on the Forum here) and Index Funds and the Future of Corporate Governance: Theory, Evidence and Policy (discussed on the Forum here) both by Lucian A. Bebchuk and Scott Hirst; and The Agency Problems of Institutional Investors (discussed on the Forum here) by Lucian A. Bebchuk, Alma Cohen, and Scott Hirst.

We study how the arrival of firm-specific information during earnings announcements affects liquidity in over-the-counter (OTC) markets. Extensive research has found a decline in equity market liquidity during earnings announcements due to heightened information asymmetry. However, another friction in many markets (e.g., corporate loans and bonds, nonstandard derivatives, and municipal bonds with OTC structures) is search and bargaining costs, where investors must first search for a counterparty and then bargain over the terms of trade. To understand how earnings announcements shape liquidity in these securities markets, we must understand how these frictions interact jointly during earnings announcements.

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Weekly Roundup: March 8-14, 2024


More from:

This roundup contains a collection of the posts published on the Forum during the week of March 8-14, 2024

Retail Investors and Corporate Governance: Evidence from Zero-Commission Trading



Guide to Becoming a Model Code Company


A Guide for Directors to Political Law Issues in This Election Year


Banking and Antitrust


2023 Activism Recap


Sears and (the Limited Scope of) Controlling Stockholder Fiduciary Duties


Harnessing the overconfidence of the crowd: A theory of SPACs


Shareholder Activism Annual Review 2024


SEC Enforcement: 2023 Year in Review




Chancery Addresses Fiduciary Duty Claims Arising from Reincorporation to Nevada


Corporate responses to stock price fragility



Directors’ responsibilities to stakeholders, particularly employees

Richard A. Gephardt is President and CEO of Gephardt Group. Mr. Gephardt served in the United States House of Representatives from 1976 to 2004, representing Missouri’s 3rd Congressional District. He served as House Democratic Leader for more than 14 years, as House Majority Leader from 1989 to 1995 and Minority Leader from 1995 to 2003. Mr. Gephardt ran as a Democratic candidate for U.S. President twice, in 1988 and 2004. Related research from the Program on Corporate Governance includes Lifting Labor’s Voice: A Principled Path Toward Greater Worker Voice And Power Within American Corporate Governance by Leo E. Strine, Jr., Aneil Kovvali, and Oluwatomi Williams; Stakeholder Capitalism in the Time of COVID (discussed on the Forum here) by Lucian A. Bebchuk, Kobi Kastiel, and Roberto Tallarita; and The Illusory Promise of Stakeholder Governance (discussed on the Forum here) by Lucian A. Bebchuk and Roberto Tallarita.

After 28 years in the US House of Representatives, I had the privilege of serving on five different public Boards of Directors, including Ford Motor Corporation, US Steel, Century Link, Centene and Spirit Aerosystems.

In addition, I have had an opportunity to work with numerous other public corporations to help them have a more mutually beneficial relationship with all of their employees.

The main lesson I learned from all of those experiences is that corporate boards and corporate leadership cannot create or sustain a successful corporation if their sole and only focus is on the interests of their investors.

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Corporate responses to stock price fragility

Richard Friberg is the Jacob Wallenberg Professor of Economics at the Stockholm School of Economics, Itay Goldstein is the Joel S. Ehrenkranz Family Professor of Finance at the Wharton School of the University of Pennsylvania, and Kristine Hankins is the William E. Seale Professor of Finance at the University of Kentucky. This post is based on their article forthcoming in the Journal of Financial Economics. Related research from the Program on Corporate Governance includes Stock Investors’ Returns are Exaggerated (discussed on the Forum here) by Charles Wang, Jesse M. Fried, and Paul Ma.

Meme stock trading and consolidation in the asset management industry seem like unrelated topics but both can contribute to non-fundamental stock price movement. That is, they increase stock fragility – the risk of future misvaluation.

Does this matter for firms? How do executives react?

Our recently accepted Journal of Financial Economics paper “Corporate Responses to Stock Price Fragility” provides novel evidence that firms respond to price fragility stemming from changes in the composition of investors. Specifically, firms increase cash and decrease investment in response to the risk of future misvaluation.

While existing research often investigates the impact of non-fundamental mispricing shocks on corporate finance outcomes such as investments and takeovers, we document firms alter their financial behavior when anticipating increased stock price fragility. This offers new insights into the link between financial market shocks and corporate decisions.

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Chancery Addresses Fiduciary Duty Claims Arising from Reincorporation to Nevada

Amy Simmerman, Brad Sorrels, and David Berger are Partners at Wilson Sonsini Goodrich & Rosati. This post is based on a Wilson Sonsini memorandum by Ms. Simmerman, Mr. Sorrels, Mr. Berger, Joe Slights, and Tiphanie Cascella and is part of the Delaware Law series; links to other posts in the series are available here.

On February 20, 2024, Vice Chancellor J. Travis Laster of the Delaware Court of Chancery issued an opinion refusing to dismiss stockholder claims challenging the reincorporation of TripAdvisor from Delaware to Nevada and determining that the entire fairness standard of judicial review, rather than the business judgment rule, applied to the decision to reincorporate. The essence of the court’s determination was that the purpose of the reincorporation was to reduce stockholder litigation risks for its fiduciaries and that a reduction in the litigation rights of stockholders in a controlled company creates a non-ratable benefit for the controller. Accordingly, the standard of review governing the transaction is entire fairness unless the company uses some type of procedural protections, such as approval by an independent board committee and/or minority stockholders, to lower the standard of review by simulating an arm’s-length negotiation. Because no such steps were taken here, the court denied the defendants’ motion to dismiss and allowed the case to proceed under the entire fairness standard.

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