Yearly Archives: 2008

Responding to Hedge Fund Activism

Posted by Andrew Tuch, co-editor, HLS Forum on Corporate Governance and Financial Regulation, on
Tuesday, April 22, 2008
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This post is by Matteo Tonello of The Conference Board Governance Center.

The Conference Board’s Working Group on Hedge Fund Activism, established in May 2007, recently released a set of proposed recommendations for those public companies and institutional investors who might find themselves involved in an activism campaign mounted by hedge funds. The proposed recommendations are supported by a white paper discussing the Working Group’s findings. The paper is available here.

The Working Group focused on the following areas:

1. What corporations can do to better monitor securities holdings and learn about those accumulations of stock or extraordinary trading patterns that may reveal a hedge fund’s activism tactic.

2. What measures corporations can adopt to avoid becoming a target.

3. How boards and senior executives can react to an activism campaign and how they should respond to requests for change made by hedge funds.

4. How companies and large institutional investors can ensure integrity of the voting process in those situations where hedge funds borrow shares for the sole purpose of influencing a shareholders’ vote.

5. What considerations institutional investors should be mindful of when allocating some of their assets to hedge funds pursuing activism strategies.

Any interested party is invited to comment on the white paper and proposed recommendations. Comments and requests for information should be addressed to the author, Matteo Tonello, at 212-339-0335 or [email protected]. The comment period will run until April 30, 2008.

Option Backdating and Its Implications

Posted by Jesse Fried, Harvard Law School, on
Monday, April 21, 2008
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This post is from Jesse Fried of Harvard Law School. The blog featured earlier posts on the option backdating and its corporate governance implications by Larry Ribstein here, by Ted Mirvis and Paul Rowe here, and by Lucian Bebchuk here, here, here, here, and here.

I have just posted on SSRN a paper that analyzes three forms of secret option backdating used by public firms and their significance for various corporate governance debates: Option Backdating and Its Implications. The current draft is available on SSRN here.

The three forms of option backdating analyzed are: (1) the backdating of executives’ option grants; (2) the backdating of non-executive employees’ option grants; and (3) the backdating of executives’ option exercises. The paper shows that each type of backdating less likely reflects arm’s-length contracting than a desire to inflate and camouflage executive pay. Secret backdating thus provides further evidence that pay arrangements have been shaped by executives’ influence over their boards. The fact that thousands of firms continued to secretly backdate after the Sarbanes Oxley Act, in blatant violation of its reporting requirements, suggests recent reforms may have failed to adequately curb such managerial power.

As I am continuing to work on this paper and a number of related projects, any comments would be most welcome.

NYCERS v. Apache Corp: Remember Cracker Barrel?

Posted by the Harvard Law School Forum on Corporate Governance & Financial Regulation, on
Sunday, April 20, 2008
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Editor’s Note: This post is from Broc Romanek of TheCorporateCounsel.net.

Ah, Cracker Barrel. A decade ago, the biggest Corp Fin-related controversy was the shareholder proposal’s “ordinary business” exclusion basis and the SEC Staff’s Cracker Barrel no-action letter under Rule 14a-8(c)(7) (the basis has since been renumbered to 14a-8(i)(7)). Those were much simpler times. Back then, the SEC’s dealings in corporate governance matters were pretty much limited to the shareholder proposal rule.

The Cracker Barrel saga arose due to a ’92 no-action letter under which Corp Fin allowed that company to exclude a anti-sexual orientation discrimination proposal by stating that all employment-related proposals raising social issues were excludable. Enough fuss was raised so that the Commission specifically overruled its Staff’s position in a ’98 rulemaking and returned the agency’s position on social issues to a “case-by-case analytical approach.” Corp Fin has been making this case-by-case determination when deliberating on social proposals ever since.

Now, a similar case has been brought in the US District Court, Southern District of Texas, by Apache Corporation, which is seeking a declaratory judgment supporting its exclusion of a shareholder proposal submitted by the New York City Employees’ Retirement System. This case seeks to enjoin a lawsuit brought by NYCERS in the Southern District of New York. The facts are as follows:

– For the last two years, NYCERS has submitted proposals to companies in a campaign designed to fight discrimination against gays/lesbians and transgendered people (eg. asking companies to amend their EEO statements a la Cracker Barrel).

– This proxy season, NYCERS submits a proposal to Apache asking for the implementation of a program based on “equality principles” that include additional steps to avoid discrimination against this group of people.

– On March 5th, Corp Fin provides no-action relief allowing Apache to omit the proposal on ordinary business grounds, noting that some of the principles in the proposal relate to ordinary business.

– On April 8th, Apache filed for a temporary restraining order to try to prevent NYCERS from delaying its annual meeting and mailing supplemental materials.

– On April 9th, NYCERS files a lawsuit in SDNY, arguing – among other things – that Corp Fin had denied no-action relief for similar proposals in the past (specifically citing these no-action responses: Armor Holdings ((i)(7) denied on burden grounds) (4/3/07) and Aquila ((i)(10) denied)(3/2/06)) and that the Court doesn’t owe deference to Corp Fin’s positions anyways.

– After it filed its lawsuit, NYCERS subsequently filed for a temporary restraining order, but then quickly changed its request to an affirmative/mandatory injunction to force Apache to deliver supplemental proxy materials ahead of its May 8th annual meeting.

This is where this battle stands today, although it promises to move quickly. We have posted all of the documents filed in the SDTX and SDNY so far in our “Shareholder Proposals” Practice Area on TheCorporateCounsel.net.

Delaware Court Upholds Bylaw Amendment that Cuts Off Advancement Rights to Former Directors

Posted by Steven M. Haas, Hunton & Williams LLP, on
Saturday, April 19, 2008
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This post is from Steven M. Haas of Hunton & Williams LLP. This post is part of the Delaware law series, which is cosponsored by the Forum and Corporation Service Company; links to other posts in the series are available here.

On March 28, the Delaware Court of Chancery issued a decision in Schoon v. Troy Corporation, upholding a board-approved bylaw amendment that cut-off advancement rights to a former director. I previously posted here on related litigation between the parties where the court held that directors do not have standing to bring derivative suits.

At issue this time was an amendment to the company’s advancement bylaw, which originally provided that “the Corporation shall pay the expenses incurred by any present or former director.” After a director left the board but shortly before he became involved in litigation with the company, the existing board amended the bylaw to delete the reference to “former” directors.

Once litigation began, the director claimed a vested right to mandatory advancement because the lawsuit related to his official capacity as a former director when the original bylaw was in place. As a result, the bylaw amendment arguably had no affect on his advancement rights. He relied on a prior Delaware decision, Salaman v. National Media Corp., 1992 WL 808095 (Del. Super. Oct. 8, 1992), holding that a board of directors cannot unilaterally terminate a former director’s right to advancement through a bylaw amendment while litigation is pending.

The Court of Chancery rejected the former director’s argument and upheld the bylaw amendment that denied him mandatory advancements. It reasoned that a director’s right to advancement becomes “vested” when litigation is filed, not when the underlying conduct allegedly occurred. This holding may surprise some practitioners, given that the purpose of indemnification and advancement is to encourage board service and assure directors that their expenses relating to their official actions will be paid—even if litigation arises after they resign from the board. In addition, this holding was in spite of another bylaw provision providing that “[t]he rights conferred by this Article shall continue as to a person who has ceased to be a director or officer and shall inure to the benefit of such person.” The court explained that this provision “is better understood as providing that a director, whose right to advancement is triggered while in office, does not lose that right by ceasing to serve as a director” (emphasis added).

Decisions affecting directors’ rights to advancement and indemnification are always significant. This decision, in particular, may have important implications for dissident directors and directors who are ousted in proxy contests. Both litigators and drafters should take note.

The opinion is available here.

The Role of the States – Foreign and Domestic

Posted by the Harvard Law School Forum on Corporate Governance & Financial Regulation, on
Friday, April 18, 2008
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The General Counsel of the Securities and Exchange Commission and Harvard Law School graduate, Brian G. Cartwright, recently gave the Distinguished Scholar Address at Widener University School of Law. Entitled The Role of the States (Foreign and Domestic), the speech addressed the question of what the increasingly global nature of securities markets and business will mean for Delaware general corporation law. After reflecting on changes in securities investing and commerce in recent decades, Mr. Cartwright envisioned a world in which “a global stockholder base trades the stock of transnational companies in just a few market centers with a global reach.” As greater parts of the world embraced the benefits of free-market capitalism, he predicted, the U.S. might lose the commanding dominance it once enjoyed, although it would likely remain one of the world’s leading capital markets. Mr. Cartwright likened competition for corporate charters in the U.S. to the situation now prevailing in Europe, and questioned how state competition for corporate charters would play out at the international level.

The speech is available here.

AFL-CIO Proxy Voting: A Response by Agrawal

Posted by Andrew Tuch, co-editor, HLS Forum on Corporate Governance and Financial Regulation, on
Thursday, April 17, 2008
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The Agrawal study is described on our blog here; the initial AFL-CIO response is available on our blog here; two reactions to that AFL-CIO response – from Ashwini Agrawal and from Steven Kaplan – are available here; the subsequent AFL-CIO response is available here.

I am writing to respond to the recent post by Daniel Pedrotty, director of the AFL-CIO Office of Investment, critiquing my study on AFL-CIO proxy voting.

First, in contrast to Pedrotty’s claim that I was never in contact with the AFL-CIO Office of Investment, I contacted Michele Evans, office administrator of the AFL-CIO Office of Investment by email on May 22, 2007, and received a reply from her by email on June 1, 2007. The email exchange is available here.

Second, I would like to respond to Pedrotty’s request that I share my data with the AFL-CIO on a confidential basis with the AFL-CIO committing not to share it with any rival researcher and to use it solely to “check the accuracy” of my findings. Given that the AFL-CIO has not provided me data and information when I have requested it and has made what I consider false and misleading statements about my research, I have serious concerns, as do my advisors, that the AFL-CIO will misuse and mischaracterize any data I send them prior to publication. I therefore will not enter into the requested confidentiality agreement with them. Instead, I suggest they consult the public sources of data I use in writing my paper and replicate the findings themselves.

Third, I would like to respond to Pedrotty’s claim that the study is not possible to replicate using public information. Pedrotty makes a useful point that I did not fully describe the information I obtained from Investor Relations departments, however, as I will make clear in the next version of the paper, the findings in the paper are the same if one relies on the public data sources described in the paper. The next draft will explain that I contacted four companies whose investor relations departments confirmed, consistent with the lack of discussion of unionized workers in their 10-K’s, that they did not have union workers (an assumption I discuss in the paper). I will also make sure to fully describe any information I get from additional investor relations departments or other sources that I may choose to contact while revising my study.

As for other claims raised by Pedrotty, I have addressed them already in my earlier post, available here.

Ringling Bros.-Barnum & Bailey Combined Shows v. Ringling

Posted by Mark Ramseyer, Harvard Law School, on
Wednesday, April 16, 2008
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This post is from Mark Ramseyer of Harvard Law School.

The Program on Corporate Governance has recently issued as a discussion paper my piece, entitled Ringling Bros.-Barnum & Bailey Combined Shows v. Ringling: Bad Appointments and Empty-Core Cycling at the Circus.

On the surface, the Ringling case appears to be an irrational spat over board seats by the heirs of a very successful enterprise. However, a closer inspection reveals that the investors were neither fighting over board seats nor were they irrational. Although Edith Ringling pushed her incompetent son and Aubrey Haley her inappropriate husband, they did so to their private advantage. Although the circus cycled from one management team to another, the investors always promoted the new teams for private gain.

I argue that the root of the Ringling dispute lay in the inability of the law to enforce duty-of-loyalty standards. When the law works as it should, fiduciary duties perform two functions: they remove the incentive to appoint corporate officials by kinship rather than ability, and prevent the empty core cycling that would otherwise plague so many close corporations. Here it performed neither. In the Ringling case, I argue that the various parties had incentives to defect in the next period regardless of the alliances they formed in the current period. When the law does not enforce a duty of loyalty, this allows cycling to occur. If the law gave each investor a return proportional to his or her interest in the firm, investor alliances would not cycle. Not only will investors not appoint inept kin, management will not cycle from alliance to alliance. The Ringling circus did not degenerate into the chaos in which it found itself because the investors were spoiled or irrational. It degenerated because the law could not enforce the duty of loyalty.

The full paper is available for download here.

TravelCenters of America LLC v. Brog

Posted by Rodman Ward, Skadden, Arps, Slate, Meagher & Flom LLP, on
Tuesday, April 15, 2008
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This post is from Rodman Ward of Skadden, Arps, Slate, Meagher & Flom LLP. This post is part of the Delaware law series, which is cosponsored by the Forum and Corporation Service Company; links to other posts in the series are available here.

Chancellor Chandler in litigation captioned TravelCenters of America LLC v. Brog, et al., C.A. No. 3516-CC decided, among other issues, two significant legal questions worthy of broader publication. Since both rulings are contained in memorandum opinions, they will not be reported officially. The first ruling was contained in a pre-trial memorandum opinion and dealt with the admissibility of a law professor’s expert testimony on matters of state and federal law. The second, contained in a bench memorandum delivered at the end of the trial, decided whether provisions contained in an LLC Agreement were required to comport with concepts of “good corporate governance.”

I. Law Professor Testimony
In the pre-trial ruling, the Chancellor held that expert testimony from a law professor (a) could not be presented on the question as to whether, under Delaware law, the LLC’s provisions regarding advance notice were consistent with good corporate governance practices but (b) could be presented as to whether the Notice complied with the Agreement’s incorporation of federal securities law disclosure. The first holding was based on an unreported opinion in the Court’s earlier Disney litigation which had held that “‘in this Court, witnesses do not opine on Delaware corporate law.” The pre-trial ruling foreshadowed the result of the case in chief by stating that: “Delaware does not impose a legal requirement on LLCs to draft their bylaws to be consistent with some abstract notice of good corporate governance. LLCs are creatures of contract designed to afford the maximum amount of freedom of contract, private ordering and flexibility to the parties involved.”

The Court did allow expert testimony (a) on the requirements of federal securities law and, (b) citing an unreported opinion in the Court’s Wells Fargo v. First Interstate Banking litigation, as to the materiality of omissions as measured by the standards of federal securities law. Wells Fargo, relying on TSC v. Northway, had held that “issues of materiality are generally held to be mixed questions of law and fact but predominantly questions of fact.”

The pre-trial ruling is available here.

II. LLC Agreement Provisions
In the case in chief, the Chancellor granted TravelCenters’ declaratory judgment that the activist stockholder plaintiff’s notice of intended nomination of board members at the annual meeting (the “Notice”) was contrary to the LLC Agreement and “of no force or effect.”

The Court found that the Notice violated a requirement in the Agreement that such notices disclose all the information that the Exchange Act would require to be disclosed in a proxy solicitation. The decision was based on the legal proposition that LLC’s are “creatures of contract” and are not limited by general rules applicable to corporate governance. Since valid notice was required for the nominations to be accepted at the meeting, the management slate would be expected to be unopposed.

The bench memorandum is available here.

Corporate Governance Update: Advice for Directors in Complicated Times: The Fundamentals Still Apply

Posted by David A. Katz, Wachtell, Lipton, Rosen & Katz, on
Monday, April 14, 2008
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This post is from David A. Katz of Wachtell, Lipton, Rosen & Katz.

My colleague Laura A. McIntosh and I have written an article entitled Corporate Governance Update: Advice for Directors in Complicated Times: The Fundamentals Still Apply. The article considers directors’ oversight responsibility in a volatile business environment, including directors’ obligations as a company approaches the zone of insolvency and the extent to which directors are entitled to rely on management’s and experts reports, advice and decisions. The article also discusses directors’ exposure to potential liability, including the degree of vigilance required to discharge fiduciary obligations and how active directors should be in seeking information from management.

The Changing Dynamics of Global Capital Markets

Posted by Andrew Tuch, co-editor, HLS Forum on Corporate Governance and Financial Regulation, on
Friday, April 11, 2008
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This post is by Linda McKenzie of Ernst & Young.

In light of all of the recent market turmoil, the importance of transparency and risk management has certainly been elevated. These issues along with some of the shifts in global capital markets activity are at the center of a speech delivered by my CEO at Ernst & Young, Jim Turley, to a Washington D.C. audience at the U.S. Chamber’s 2nd Annual Capital Markets Summit. The speech describes how the interconnected, complex, and dynamic nature of global capital markets is demanding greater transparency, increased focus on risk management, and development of common standards and practices around the globe. Jim suggested the launch of a sustained multi-party dialogue — some mechanism involving issuers, auditors, and investors as well as governments and regulators — to facilitate a private and public sector dialogue that would monitor, assess, and address the challenges of operating in global capital markets and help to identify best practices. Tackling these issues could set a foundation for higher levels of investor confidence. The full text of the speech is available here.

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