A Response to Professor Macey

Joseph A. Grundfest is the W. A. Franke Professor of Law and Business at Stanford University Law School. This post responds to a post, titled SEC Commissioner, Law Professor Wrongfully Accuse SRP of Securities Fraud, by Yale Law School Professor Jonathan R. Macey (available on the Forum here). The post by Professor Macey offered a critique of a paper by SEC Commissioner Daniel M. Gallagher and Stanford law School Professor Joseph A. Grundfest, described in a post by Professor Joseph Grundfest (available on the Forum here).

In a December 15, 2014, post to this Harvard Corporate Governance blog, (here) Professor Jonathan R. Macey suggests that the article I co-authored with Dan Gallagher, “Did Harvard Violate Federal Securities Laws? The Campaign Against Classified Boards of Directors,” (here) wrongfully accuses Harvard’s Shareholder Rights Project of fraud. Professor Macey’s post presents a detailed critique, and I greatly appreciate Harvard’s courtesy in providing this opportunity for response.

But before proceeding, it bears emphasis that Professor Macey and I agree on a very significant point: Substantial literature directly challenges the empirical evidence the Harvard Proposal proffers to justify its request for shareholder support. This literature finds that declassifying boards harms shareholder interests. The Harvard Proposal cites to none of the research that opposes its position. On this much, Professor Macey and I agree.

The question on the table is, therefore, not whether the Harvard Proposal presents a fair summary of the current state of the academic research regarding classified boards. It does not. That is undisputed. The question is whether the SEC’s rules require that it do so. This is where Professor Macey and I part company.

It takes some fancy footwork even to argue that the Harvard Proposal, with its glaring omissions, complies with SEC regulations. And, I am happy to concede that Professor Macey is a talented and clever dancer. But the problem with Professor Macey’s arguments in defense of the Harvard Proposal is that they get tripped up by the facts and the law.

I address each of Professor Macey’s arguments, point by point:

A. Professor Macey’s first argument rests on the fact that the Proposal’s summary of the literature is introduced with the phrase “the significant shareholder support for declassification proposals is consistent with empirical studies reporting that:….” (For the full text of the Harvard Proposal, see (here). I would cite to the Harvard Proposal on the Harvard SRP’s own website, but it doesn’t seem to be posted there.)

Professor Macey reasons that, by introducing its description of the empirical literature through a locution that ties significant shareholder support to the existence of a consistent body of empirical literature, the Harvard Proposal limits its disclosure obligation to articles that are consistent with its position. This locution, according to Professor Macey, absolves the SRP of any obligation to discuss any contrary literature.

While there are several strong responses to this argument, only one is necessary to defeat it. The Harvard Proposal does not limit itself to a discussion of studies consistent with shareholder support for its position. The Harvard Proposal states: “Although one study (Bates, Becher and Lemmon, 2008) reports that classified boards are associated with higher takeover premiums, this study also reports that classified boards are associated with a lower likelihood of an acquisition and that classified boards are associated with lower firm valuation.” The Harvard Proposal thus represents that shareholder support for its position is also consistent with studies that claim to find that staggered boards are harmful because those studies can be minimized or distinguished. The Proposal refers to only one study, and twists it into the same category of studies it embraces as supporting (or at least not rejecting) the Proposal’s conclusion.

The law is clear that once one speaks to a matter, one assumes the obligation to speak truthfully and completely, even if one was under no initial obligation to speak at all. See e.g., Roeder v. Alpha Indus., Inc., 814 F.2d 22, 26 (1st Cir. 1987) (“When a corporation does make a disclosure—whether it be voluntary or required—there is a duty to make it complete and accurate”). So, by citing to negative research, most particularly in a context in which the SRP itself describes the opposing scholarship as consistent with shareholder support, the SRP voluntarily assumes an obligation to speak truthfully and completely as to the state of the opposing research. Instead, the Proposal goes in precisely the opposite direction. It cherry picks the literature and sets up a straw-man argument based on a single study that is not characteristic of the more substantial recent research. It then bats down the straw-man it raises up. (Professor Macey in his post nowhere addresses the reference to this one opposing piece of research or the legal implications of that reference.)

Thus, even if one assumes that the Harvard Proposal could have been written in a manner that would have avoided the obligation to discuss opposing research findings, it was not written in that manner. Instead, its phrasing clearly triggered an obligation under the law to present a fair picture of the opposing research. It did not fulfill that obligation.

B. Professor Macey objects to the notion that Rule 14a-8 proposals must be judged on a “stand alone” basis (i.e., within the four corners of the proposal itself), and not with respect to the company’s ability to respond. The first problem with this position is that it is contrary to the law, which clearly states that the proponent’s proposal must not contain material omissions. The law does not provide that the proposal plus the company’s response, taken together, must not contain material omissions. See 17 C.F.R. § 240.14a-8(i)(3) (“If the proposal or supporting statement is contrary … to Rule 14a-9″ then the company may exclude the proposal) (emphasis supplied); SEC Staff Legal Bulletin No. 14B (Sept. 15, 2004) (“[T]he staff will concur in the company’s reliance on Rule 14a-8(i)(3) to exclude or modify a proposal or statement only when that company has demonstrated objectively that the proposal or statement is materially false or misleading.”) (emphasis supplied).

The recent decision in Express Scripts Holding Co. v. Chevedden, No. 13–2520, 2014 WL 631538 (E.D. Mo. Feb. 18, 2014), underscores this point. There, the proponent’s proposal contained four misstatements of fact. If the court had rejected with the rule’s “stand alone” requirement, it would have forced the company to include the defective proposal and deemed the record corrected by considering the company’s response. But that’s not what the court ruled. It held that the proposal was false and misleading, on a stand-alone basis, and could therefore be excluded. That’s the “stand alone” theory in action. Any effort to distinguish Express Scripts from the Harvard Proposal on the basis that Express Scripts involved a misrepresentation whereas the Harvard Proposal involves an omission also fails as a matter of law because the law here draws no distinction between a material misrepresentation and a material omission.

A second problem with the approach Professor Macey erroneously posits as the law is that it puts the company in the position of acting as the proponent’s nanny subject to an expectation that will correct any deficiencies that might be present. This result is directly contrary to the rule that the company “is not responsible for the contents of [a] proposal or supporting statement.” See 17 C.F.R. § 240.14a–8(l)(2).

A third problem is that, as of the date a proposal is submitted, no response exists. The staff would therefore find it impossible to judge the compliance of the combined proposal and response under Rule 14a-9. And, if the proponent objected to the company’s response, would the proponent then have a right to insist that the staff force the company to change its response, but that the proponent not be required to change its proposal? And, where would this infinite loop end?

The only way to avoid these legal and practical problems is to respect the “stand alone” interpretation. It is sound, pragmatic policy. It is also the law.

More fundamentally, however, this entire debate over the “stand alone” policy misses a simpler, more central question: Is it really that hard to write a proposal that complies with the law? I don’t think so. Could the Harvard Proposal be re-written to comply with the law? Of course it could.

C. Professor Macey’s third major point is a collection of sub-points relating to the “totality of disclosures” approach he advocates, but which is, as I suggest, contrary to the law and generates a host of practical problems.

  • Professor Macey correctly observes that Rule 14a-8 has a strict 500 word limit. The Harvard Proposal, which runs to about 400 words, can be brought into compliance within the existing 500 word limit many different ways. In addition, the Harvard Proposal is allowed to link to webpages, and only the URL’s address would count against the 500 word limit. The potentially thousands of words at the linked cites don’t count against that limit, but the material at the link must not violate Rule 14a-9. See SEC Staff Legal Bulletin No. 14 (July 13, 2001), available at http://www.sec.gov/interps/legal/cfslb14.htm (“Because we count a website address as one word for purposes of the 500-word limitation, we do not believe that a website address raises the concern that rule 14a-8(d) is intended to address. However, a website address could be subject to exclusion if it refers readers to information that may be materially false or misleading, irrelevant to the subject matter of the proposal or otherwise in contravention of the proxy rules.”). Linking to materials outside the four corners of the proxy thus is another way to address concerns related to brevity.
  • Professor Macey explains “the core purpose of Rule 14a-8 is to permit proponents … to advocate a particular position. Accusations of fraud must be considered in that context particularly since companies who receive 14a-8 proposals may respond to them.” This simply restates the argument against the “stand alone” policy. That point has already been addressed.
  • “Companies responding to shareholder proposals can convey counter-arguments and cite the sort of data that Gallagher/Grundfest assert should have been adduced in the SRP proposal …. This, it seems to me, is a fatal flaw in the brief [sic] being circulated by Gallagher/Grundfest.” Again, this point simply reiterates Professor Macey’s dissatisfaction with the “stand alone” policy, and, again, Professor Macey presents no support in the law for his position. Indeed, rather than being a “fatal flaw,” reliance on the “stand alone” principle is the only position consistent with the law. I view compliance with the law as a virtue, not a fatal flaw.
  • The Netflix example cited by Professor Macey actually undercuts his argument. Netflix responded to the Harvard Proposal by noting that the “studies cited by the proponents have been called into question by more recent and more comprehensive research,” and then proceeded to discuss some but not all of the literature in opposition. Professor Macey observes that “tellingly, Netflix listed only recent studies that supported staggered boards but did not list any of the recent studies supporting board declassification that Gallagher/Grundfest discuss.” But should it be assumed that, if a proponent submits a defective proposal, it then becomes the company’s burden to correct and supplement that proposal even if the company opposes the proposal? Putting aside the fact that this approach would, quite remarkably, impose on the “defendant” the obligation to strengthen the “plaintiff’s” argument, the law is clear that the company cannot be held liable for deficiencies in the proponent’s proposal. Yet, Professor Macey would turn the law on its head to create precisely such an obligation. Professor Macey cites to no precedent in support of this position and, to my knowledge, no such precedent exists. (Disclosure: The general counsel at Netflix contacted me when he received the Harvard Proposal in 2013. I provided information about research findings opposing the Harvard Proposal’s position. I did not and do not represent Netflix, and was not compensated by Netflix. This was also the first occasion on which I saw the text of the Harvard Proposal. If it is at all relevant, it is trivially easy to defend Netflix’s decision not to discuss the additional literature in support of the proponent’s position because: (1) it is not legally required to do so, and (2) the addition of those citations could be argued to be immaterial given the disclosures already contained in the proposal. The paper I co-authored never takes the position that a full bibliography is necessary for Rule 14a-9 compliance.)

D. Professor Macey correctly observes that the preferred way to deal with potentially defective shareholder proposals is to seek no-action relief from the SEC staff. But, as explained in the paper, the staff has stepped so far back from conducting integrity reviews of shareholder proposals that companies view the no-action process as a futile gesture when it comes to claims of material omissions or misrepresentations. And that’s precisely the scenario that gives rise to the fact pattern observed in Express Scripts. There, according to the court’s recitation of the facts, the company didn’t even bother seeking a no-action letter, despite the fact that the proposal contained four clear misrepresentations. Instead, the company took the more expensive path of going straight to court, where it prevailed.

If Professor Macey is willing to join in an effort to put a bit more backbone in the staff review process, I would welcome his participation. Today, however, the only alternative to improved SEC review is, unfortunately, litigation, and we agree that litigation should be avoided, if possible.

E. Professor Macey suggests that “if the staff is willing to entertain exclusions because they are vague, they would likely be even more willing to entertain claims by companies that SRP proposals were false and misleading….” Here, Professor Macey makes an excellent, perfectly logical point. If the staff is willing to roll up its sleeves on the question of vagueness, why not on the question of accuracy? I agree, and effectively ask the same question. But I also observe that in Staff Bulletin 14B, for reasons of resource allocation, the staff takes a strong step back from “integrity” review, yet it continues with “vagueness” review. If Professor Macey’s point is that the staff should be more engaged in the “integrity” review process, we again agree and I again invite his cooperation in persuading the staff to adopt our shared view.

F. Professor Macey is concerned that the paper’s approach would tilt the proposal process against shareholders because management would be able to fashion limitless pretexts “for excluding shareholder proposals involving issues of complex science such as climate change, or involving entrenchment devices such as shareholder rights plan….” I share Professor Macey’s concern, and do not desire this outcome, but I also observe that it is not difficult to avoid many of the problems that animate Professor Macey’s parade of horribles. Proponents can take greater care by avoiding sweeping generalizations, presenting more modulated positions, and by distinguishing their opinions from objectively verifiable fact. In this context, it is important to emphasize that a shareholder proposal is not a soap-box in Hyde Park. It is a document subject to liability under Rule 14a-9. This is a distinction with a difference.

G. Professor Macey observes that the paper fails to point to a single instance of a “case or enforcement action taken against a shareholder proponent for fraud.” I agree, and also know of no such case. But that does not suggest that any portion of the paper’s analysis is incorrect. There are many possible explanations for the absence of such precedent that are entirely unrelated to the accuracy of the paper’s analysis.

H. Professor Macey is also entirely correct that the paper’s “real quarrel is not limited to the SRP Proposals: it reflects a general indictment of the way that the SEC staff currently handles 14a-8 proposals.” The best path forward, I agree, is not litigation against anyone. The best path forward would have the staff step to the plate by providing a meaningful opportunity for an “integrity” review of proponents’ statements. But, until that day comes, litigation is the only recourse available to parties who complain about the legal requirement that they include a shareholder proposal in the company’s proxy materials even if that proposal is materially false and misleading.

Finally, with regard to footnote 29, in which, for purposes of the analysis, and in order to be as conservative and as pro-Harvard as could be (at least on this one point), our claims were limited to instances in which the Harvard Proposal appeared after January 2014. Professor Macey asserts that this cutoff date results in a situation in which “none of the SRP proposals was actionable … because the proposals had been submitted before January 6, 2014.”

This conclusion is incorrect. It rests on an incomplete rendition of the facts and on an inaccurate comprehension of the law. The public record shows that the Harvard Proposal went to a vote on seven distinct occasions in 2014. The Harvard SRP’s website is consistent with this count. See 65 Successful Precatory Proposals by SRP-Represented Investors, Shareholder Rights Project, available at http://srp.law.harvard.edu/companies-voting-on-proposals.shtml (last visited Dec. 16, 2014).

Company Meeting Date
1 Huntington Ingalls April 30, 2014
2 Akamai May 14, 2014
3 Insight Enterprises May 14, 2014
4 Vornado Realty Trust May 22, 2014
5 WPX Energy May 22, 2014
6 Netflix June 9, 2014
7 Airgas August 5, 2014

Professor Macey suggests that a shareholder proposal becomes fixed as of the time it is submitted and need not be amended or withdrawn even if subsequent events render it false or misleading, either by commission or omission, prior to the vote. This is not the law. Rule 14a-9(a) states that the proxy solicitation must be accurate “at the time … it is made.” The Rule also expressly contains a duty to update by imposing an obligation “to correct any statement in any earlier communication with respect to the solicitation of a proxy for the same meeting or subject matter which has become false or misleading.” Thus, “Rule 14a-9 specifically requires that solicitation material which has become false or misleading must be corrected by subsequent materials.” Gould v. Am. Hawaiian SS Co., 351 F. Supp. 853, 868 (D. Del. 1972). If proxy materials are “accurate when initially approved,” they should be “amended to reflect subsequent occurrences or changes which rendered the initial disclosure false or misleading.” Id.

Consistent with this principle, the Commission’s staff has explained that “if the information on a website changes after submission of a proposal and the company believes the revised information renders the website excludable under Rule 14a-8, a company seeking our concurrence that the website reference may be excluded must submit a letter presenting its reasons for doing so.” Under these circumstances, the “staff may grant the company’s request that the 80-day [notice] requirement be waived.” See SEC Staff Legal Bulletin No. 14G (Oct. 12, 2012), available at http://www.sec.gov/interps/legal/cfslb14g.htm.

If a proposal become excludable after it is submitted, the proponent can negotiate with the company to correct the proposal, the company can seek to exclude the proposal, or the proponent can withdraw the proposal so that the shareholders aren’t faced with the task of voting on a proposal that violates Rule 14a-9. The proponent doesn’t get a pass from the obligation to assure that its proposal is accurate and updated.

As explained by footnote 29, the paper could also have taken the more aggressive position that all proposals appearing after September 7, 2011 are defective. That earlier date would encompass the vast majority of the instances in which the Harvard Proposal has appeared. If it becomes material to the analysis, that argument could easily be made. But I do not think such a modification of the paper’s position is necessary. An example based on seven instances of proxy rule violations is sufficient to make the point. I see no need to push the count to the vicinity of 100 violations.

Both comments and trackbacks are currently closed.
  • Subscribe or Follow

  • Supported By:

  • Program on Corporate Governance Advisory Board

  • Programs Faculty & Senior Fellows