Professor Grundfest’s Latest Reply Flip-Flops Allegations and Further Demonstrates that He and Commissioner Gallagher Wrongfully Accused the SRP

Jonathan R. Macey is the Sam Harris Professor of Corporate Law, Corporate Finance & Securities Law at Yale University. This post provides a detailed response to a reply post authored by Professor Joseph A. Grundfest and endorsed by Commissioner Daniel Gallagher, titled No Good Deed Goes Unpunished: A Reply to Professor Macey’s Reply, and available on the Forum here. This reply post engaged with earlier posts by Professor Macey available on the Forum here and here, which offered a critique of a paper by Commissioner Gallagher and Professor Grundfest, titled Did Harvard Violate Federal Securities Law? The Campaign Against Classified Boards of Directors (described in a post on the Forum here).

This post is my second—and I hope final—response to the unsuccessful attempts by SEC Commissioner Daniel Gallagher and Professor Joseph Grundfest to address my criticism of the paper released by them last month (hereinafter “the Paper,” described on the Forum here). In my first post, “SEC Commissioner, Law Professor Wrongfully Accuse SRP of Securities Fraud” (hereinafter “My First Post,” available on the Forum here), I analyzed the spurious claims against the Shareholder Rights Project (SRP) that Gallagher/Grundfest put forward. In this post I address the authors’ most recent reply to my latest post. This most recent reply again shifts allegations dramatically and fails to address the identified flaws in the authors’ analysis. The reply thus confirms and reinforces my original position that the authors wrongfully accused the SRP.

The analysis of My First Post showed that the proposals submitted by investors working with the SRP (SRP proposals) were consistent with the law and with the long-held policies and practices of SEC staff, and I concluded that the authors had wrongfully accused the SRP. In a subsequent post titled “A Response to Professor Macey” (hereinafter “the First Reply,” available on the Forum here), Professor Grundfest attempted to offer a “point by point” detailed response to my analysis. In a response titled Professor Grundfest’s Reply Demonstrates that He and Commissioner Gallagher Wrongfully Accused the SRP (“My First Response”, available on the Forum here), I showed that (i) the First Reply dramatically modifies and weakens the authors’ allegations and (ii) the First Reply itself demonstrates, in conceding some key points that I made and in failing to address some others, that Gallagher/Grundfest wrongfully accused the SRP and should withdraw their allegations.

“There you go again”: Earlier this week, the Forum published a reply to My First Response (“the Second Reply,” available on the Forum here) authored by Professor Grundfest and endorsed by Commissioner Gallagher. Like the First Reply, the Second Reply reinforces my serious concerns about the Gallagher/Grundfest attack.

Below I first discuss the dramatic shift of allegations introduced by the Second Reply as well as the authors’ announced plan to come up with new allegations against the SRP following my debunking of the allegations in the Paper. I next discuss the authors’ consistent failure to address the deficiencies I identified in their claims. I conclude that the repeated attempts to prop up spurious claims, which are admittedly at odds with the long-held policies and practices of the SEC regarding shareholder proposals, are particularly unworthy of a sitting SEC commissioner, and I urge the authors to withdraw their allegations.

1. The Dramatic Flip-Flop of Allegations

The Second Reply shows that Gallagher/Grundfest are oddly relentless in their commitment to accuse the SRP proposals of violating SEC rules in some or other way. The Second Reply, like the First Reply, offers a dramatic change in the nature of the underlying allegations. While the authors appear irrevocably committed to their conclusion that the SRP proposals somehow violated the securities laws, the underlying specific allegations themselves keep wildly shifting.

The Paper, a detailed 70-page brief, stated that, for the purposes of the authors’ analysis, they were assuming that certain citations that they believe should have been included in the SRP proposals allegedly became material omissions as of January 2014. My First Post pointed out that, in contrast to what the authors had assumed, all the SRP proposals were, in point of fact, submitted prior to January 2014 and thus none was actionable even under the assumptions of the authors’ own (incorrect) analysis. In the First Reply, the authors retreated from their original claim that about 130 SRP proposals were actionable and alleged instead that seven SRP proposals that were submitted prior to January 2014 but voted upon after January 2014 could still be faulted somehow, allegedly because they could have been withdrawn. After My First Response pointed out how dramatic the authors’ relinquishing of claims was, the Second Reply thanked me for helping the authors “to strengthen the coming revision” of the Paper, and announced a plan to return to accusing all the 129 SRP proposals but to do so on the basis of new allegations that the “coming revision” would develop.

The Second Reply also explains the authors’ new plan, and it is troubling. The new plan is to develop in the coming revision four points that the Paper, the authors’ initial 70-page brief, mentioned in passing but explicitly announced that it was not invoking as a basis for the authors’ conclusion of securities law violations. For example, the coming revision is planned to accuse the SRP of illegally referring to Tobin’s Q as a measure of firm valuation, as financial economists generally do, without adding an explanation that “Tobin’s Q is a complex metric that differs from stock price valuation of market capitalization;” the planned new allegation will be that any reference to Tobin’s Q as a firm valuation measure without adding such an explanation constitutes securities fraud.

The Second Reply asserts that the choice not to pursue these four points in the authors’ initial brief was ‘”a good deed” that was not adequately rewarded and an “accommodation” that will not be repeated in the coming revision, presumably in light of the fact that my earlier posts discredited the allegations on which the authors’ brief initially relied (or perhaps because Gallagher/Grundfest simply are no longer in an accommodating mood). However, the authors’ decision not to pursue these points in their 70-page brief likely reflects not kindness toward the SRP but rather the authors’ earlier and correct judgment that those points were even weaker than their initial spurious allegations and could not provide a basis for allegations against the SRP.

The strategy of developing new allegations announced in the Second Reply appears, to me at least, to be a rather desperate attempt to salvage assertions of illegality that the authors ought to drop. A sitting SEC Commissioner who finds that allegations he made fail to hold up should not attempt to stick to his position at all costs by shifting ground and promising a coming revision that will develop new allegations he himself did not find worth pursing in his initial 70-page brief. Making up new spurious claims when earlier ones are discredited is unworthy of a sitting SEC Commissioner.

2. The Authors’ Consistent Failure to Address the Deficiencies in their Analysis

The Second Reply fails to correct the critical deficiencies in their analysis that I pointed out in my previous posts. Rather than catalogue every flaw in the authors’ work, I observe the following shortcomings:

(a) The Second Reply, like the First Reply, Admits that the SRP proposals were entirely consistent with the SEC’s current, long-held policy and practice

My First Post explained—and the authors, to their credit, now fully acknowledge—that the SRP proposals were not excludable under the long-held policy of the SEC staff and that the real quarrel of the authors was with the SEC, which the Paper accuses of an “abdication of responsibility.” The First Reply candidly admitted that the Paper’s “real quarrel is not limited to SRP proposals” and that “it reflects a general indictment” of SEC policy in this area.

Although the Second Reply, like the First Reply, admits that the authors’ main quarrel is with the SEC, it also claims that the “quarrel can be with both” the SEC and the SRP proposals. However, the authors’ initial 70-page brief failed to stress to readers that the proposals they attacked were ones that were consistent and not excludable under the long-held policies of the SEC staff. Furthermore, the authored have thus far conspicuously failed to explain why, even if they could persuade the SEC to change its policy going forward, it is at all conceivable that the SEC would take the enforcement action they urge against proposals that were submitted consistent with the SEC policies then in place.

In addition, the authors have thus far failed to explain why, given their view that the SEC’s “abdication of responsibility” have for years allowed deficient proposals to go to a vote, they chose to single out the SRP proposals for attack. As My First Post explained, “accusing an academic institution and a professor of committing fraud” for proposals that are consistent with current SEC staff policy and practice is “a strange way to criticize” the policy and practice of SEC staff and to urge a new approach.

(b) The type of enforcement action or private suit the authors urge against the SRP is without a single past precedent

Like the First Reply, the Second reply concedes that the type of enforcement action or private suit the authors urge against the SRP is without a single precedent. The authors’ 70-page brief, however, failed to stress to readers that what the authors urge is not a standard or accepted approach to a deficient proposal but rather a drastic and unprecedented change in well-settled policy and practice. In addition, the authors have conspicuously failed to explain why, among the vast number of past proposals that presumably failed to meet the authors’ new, ruthless and draconian standards, they have chosen to single out for their attack the SRP proposal and its proponents.

I note that the authors’ introduction of unprecedented enforcement actions and private suits would have massive chilling effect on shareholder proposals. As my posts explained in detail, SEC rules and policies have long wisely focused on dealing with any alleged deficiencies, such as missing references, prior to the vote on the proposal; companies facing an allegedly deficient supporting statement can either (i) seek an SEC or judicial approval for excluding the proposal or (ii) counter the proposal in the company’s opposing statement. In the Gallagher/Grundfest world, a company such as Netflix could choose to include a proposal allegedly omitting relevant references in the company’s proxy statement without any objection, include these references in the company’s opposing statement, and then sue the proponent or its advisors after the vote. It is troubling that a sitting SEC Commissioner is seeking to move us to a new regime, which would clearly have a massive chilling effect on shareholder proposals, to deal with issues that can effectively be dealt with before the vote under the current SEC rules and policies. (The authors’ additional invented strategy of going not only after proponents but also after those assisting them would further chill proposals.) For assessing the authors’ brief, however, what is important to keep in mind is the completely unprecedented nature of the actions sought. Without making this clear to readers of their brief, the authors inexplicably singled out SRP proposals in urging completely unprecedented actions against them.

(c) The weakness of the Gallagher/Grundfest claims is reflected in the fact that none of the approximately 130 S&P 500 or Fortune 500 companies that received SRP proposals raised a claim of material omission

My First Post and My First Response pointed out that none of the companies receiving SRP proposals, including Netflix which was advised by Professor Grundfest and companies represented by Wachtell Lipton which now endorses the allegations in the Gallagher/Grundfest paper, raised a claim that the proposals had the alleged deficiencies. The natural explanation for this pattern is that major companies and their expert advisers did not view the SRP proposals as deficient and thus excludable under SEC rules.

The Second Reply makes up alternative but dubious explanations. For example, the Second Reply suggests that companies might have been “concerned about the adequacy of the remedy that courts might grant.” However, a declaratory judgment permitting exclusion of the proposal would be the long-accepted standard and natural remedy in any case in which a company could have convinced a court that the SRP proposal was false and misleading as the authors allege.

The Second Reply also speculates that the companies and their lawyers might not have thought about the non-inclusion of references discussed by Gallagher/Grundfest. However, this explanation is unsatisfactory given that some companies referred to such references in their opposing statements and given that Wachtell Lipton focused on the existence of one of these studies in a widely circulated memorandum. Consider, for example, Netflix, which was advised by Professor Grundfest and included the references favored by Gallagher/Grundfest in its opposing statement. Netflix was surely aware of the issue and presumably decided, wisely in my view, that it did not provide it with a basis for exclusion.

(d) Gallagher/Grundfest inconsistently claim that issuers such as Netflix are free to omit citations to studies that are contrary to the positions that they are taking, while simultaneously claiming that it is illegal for shareholders to do so

As I explained in My First Post, the SRP proposal listed only papers published during the period 2002-2008, and the 2014 opposition statement of Netflix stated that “the studies cited by the proposal “have been called into question by more recent and more comprehensive research.” Netflix cited two “more recent” studies Gallagher/Grundfest identified as questioning earlier research, but did not include any of the three studies that the Gallagher/Grundfest themselves identified as “more recent” studies supporting annual elections.

The Second Reply, like the Frist Reply, argues that Netflix did not have to include the more recent studies supporting the early studies because the proposal already listed studies supporting annual elections. But my point focused on the information investors were given regarding the results of more recent research. Because the proposal listed only studies from 2002-2008, it could not have corrected Netflix’s omission of references to recent studies contrary to the company’s categorical description of what “more recent research” had shown. Netflix made the choice, which both the Second Reply and the First reply inexplicably endorse, to provide investors with a categorical description of the results of recent research which does not include even a single reference to recent research that supports annual elections and the studies cited by the proponent. Thus, both the Second Reply and the First reply display a telling double standard: In the Gallagher/Grundfest world, issuers are not legally required to cite studies that are contrary to positions they take, but proponents are legally required to do so.

3. Conclusion

The Second Reply further demonstrates that Commissioner Gallagher and Professor Grundfest wrongfully accused the SRP. The repeated flip-flops of allegations, and the repeated attempts to prop up meritless claims, are unworthy of a sitting SEC commissioner. On the basis of the arguments here and in my previous posts, I urge the authors to withdraw their wrongful allegations.

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