by Cydney Posner
Today, SEC Chair Mary Jo White spoke at Tulane’s Corporate Law Institute, sharing her observations on the current state of shareholder activism, the shareholder proposal process and fee-shifting bylaws. The common theme: her aversion to gamesmanship and close-minded, reflexive behavior on all sides, which, she believes, can be harmful to companies and shareholders and contribute to unfair results.
The Current Activism Landscape
From White’s perspective, the concept of “shareholder activism” covers a wide range of activities and should not be viewed (as many reflexively do) as entirely negative. Some efforts by investors to influence a company’s management or decision-making can be constructive, she argues, leading to engagement between the company and shareholders, which she views as a good thing. In her view, the landscape in 2015 is evolving:
“While activists traditionally focused on small and significantly underperforming companies, many of them today are also targeting larger issuers that are not necessarily poor performers. Campaigns also appear to be experiencing greater success. Activist investors secured at least one board seat in roughly 73% of all proxy fights in 2014, up from the previous year’s record of 63%. And the campaign objectives appear to be shifting, with breakups, a review of strategic alternatives, and corporate control transactions featuring more prominently, and governance issues arising less frequently. Hedge funds are playing a much more prominent role in this space and their size and influence are growing; interesting, new players are joining their ranks. The total assets under management for such funds has been pegged at more than $120 billion in 2015 — a roughly 30% jump from 2014. Their growing presence has undeniably changed the corporate landscape. But is that good or bad, or both?
As you know, an intense debate is taking place in the business, legal and academic communities as to whether activism by hedge funds and others is a positive or negative force for U.S. companies and the economy. Some believe that activism of all stripes is essential to effect necessary management and board changes at underperforming companies, while others contend that certain activism results in short-term gains at the expense of companies and shareholder value in the long run. Competing economic studies have helped fuel the debate by asserting that activism leads to either increased or decreased long-term economic well-being for targeted companies. One study, for example, found that activist campaigns are followed by improved operating performance during the five-year period after the campaign, while another study observed that activists’ impact on operating performance is, at best, ‘very unclear.’”
The SEC’s role in all of this, however, is not to adjudicate the benefits or detriments of activism, but rather to make “sure that shareholders are provided with the information they need and that all play by the rules.”
She advises that “parties should be mindful of the requirements under Regulation 13D-G to file their initial and amended beneficial ownership reports on a timely basis and provide accurate and complete disclosure about their plans or proposals, rather than recite boilerplate that obfuscates their true intentions or their coordination with other investors.” (See this post regarding the consequences of failure to do so.) In crafting their communications, all parties should also be mindful of Rule 14a-9 — the prohibition against making material false and misleading statements or omissions in proxy solicitations — taking care “not to make claims or accuse others of wrongdoing without an adequate factual foundation.”
[Sidebar: As I’ve argued in the past, I think use of word “activist” in this context is misguided. I think the term should be reserved for those who are acting for the greater good, the public interest. It’s one thing to agitate for better corporate governance practices through shareholder proposals and similar means. But it’s hard to see coercion by hedge funds that causes companies to conduct buybacks or to engage in tax inversion transactions simply to increase the value of the hedge funds’ own portfolios as actions in the public interest. (See, for example, this article from Reuters discussing pressure from activist hedge funds on Walgreen’s to engage in a tax inversion transaction, pressure that was ultimately resisted.) Words matter.]
White also alluded to a recent takeover battle in which the hedge fund attempted to call an informal “shareholder referendum” and filed a proxy statement with the SEC in connection with that meeting, seeking shareholder support in favor of a non-binding resolution to sell the company. The company’s bylaws did not provide for referenda and SEC rules do not address them either. That is a matter of state law. Notwithstanding some questions about whether allowing the “proxy statement” to be filed “could give the disputed materials a form of official imprimatur,” she argued, the SEC staff “has a longstanding practice of accepting and looking at all filings, even if it is unclear whether the filing was required under our rules as a ‘solicitation.’ ….The alternative in this context would be for the referendum to go forward under the radar, without public disclosure, without SEC staff oversight, and without the protection of our rules.” Ultimately, the referendum idea was nixed in favor of calling an actual special meeting.
White’s final admonition in the takeover context:
“Even though the SEC staff does not act as a ‘merits or behavior referee,’ parties should still take a hard look at their actions and rhetoric and consider whether they are engaged in a constructive dialogue and facilitating a constructive resolution. I recognize, of course, that highly sophisticated strategies have come to dominate proxy fights and takeover bids; I have been involved in them as a private sector lawyer. And it is not my intent to threaten the vibrancy of anyone’s practice area. But I do think it is time to step away from gamesmanship and inflammatory rhetoric that can harm companies and shareholders alike. Fortunately, by some accounts, companies and activists are starting to make positive progress, as they increasingly engage with each other and negotiate outcomes that seem more mutually beneficial.” [emphasis added]
Rule 14a-8 Shareholder Proposals
White next went through the recent history of the Corp Fin staff’s decision on the Whole Foods no-action request, which sought to exclude a proxy access shareholder proposal under Rule 14a-8(i)(9), on the grounds that it directly conflicted with a proposal subsequently made by the company. (See this post.) White then divulged that, “[a]fter reviewing the proposals, counterproposals and competing arguments, I was not comfortable that I or the staff had sufficient opportunity to consider the questions and concerns that were raised about how to interpret the term ‘directly conflicts’ under Rule 14a-8 in the particular context presented. So, I requested that the staff review the appropriate application of the provision and report to the Commission on its findings.” Because the staff’s review is ongoing, White would not discuss the specifics of the proposal or staff responses, but did comment generally about Rule 14a-8. (Perhaps laying the groundwork for the staff’s change of position?)
Regarding the no-action process, she noted:
“While the staff strives for consistency and correctness in the administration of this process, their informal responses are neither ‘precedent’ nor binding on the Commission or a court. And, over time, views and interpretations may evolve, and changes may be reflected in guidance, interpretation, or rule changes if necessary. While the staff works tirelessly to review and respond to all requests consistently and in a timely manner, they have the discretion to decline to review requests for no-action letters. It is, and should be, rare for the staff to decline to review a request, but it does happen, as it did this proxy season.
There has been considerable discussion — and some not insignificant consternation — about my direction to the staff to examine the application of Rule 14a-8(i)(9) and the staff’s subsequent decision to decline this season to review requests asserting that rule as a basis for exclusion. I recognize that my direction and the staff’s decision has raised new questions and resulted in a change in how some companies were expecting to address some shareholder proposals this season. While any frustrated expectations are regrettable, my request was driven by a deeper concern that the application of (i)(9), as originally interpreted by the staff, could result in unintended consequences and potential misuse of our process. The purpose of the review is to think carefully about the application of the rule and a variety of related questions.”
Echoing Corp Fin Director Keith Higgins (and again, perhaps foreshadowing the SEC’s position on this issue), she asked
“if a management proposal is made in response to a shareholder proposal on the same subject matter, does that end the inquiry — and the company may exclude the shareholder proposal because it ‘directly conflicts’ with management’s proposal? What if the proposals have the same subject matter, but the terms differ? What if management’s proposal could be viewed as a proposal that, if adopted, may purport to provide shareholders with the ability to do something, such as call a special meeting or include a nominee for director in a company’s proxy materials, but that, in fact, no shareholder would be able to meet the criteria to do so? If a company excludes a shareholder proposal because it conflicts with the company’s own proposal on the same subject matter, should the company have to disclose to its shareholders the existence of the shareholder proposal? What if the company’s competing proposal was offered only in response to the shareholder’s proposal — should the company have to disclose its motivations for its own proposal? …. In impartially administering the rule, we must always consider whether our response would produce an unintended or unfair result. Gamesmanship has no place in the process.” [emphasis added]
Fee-Shifting Bylaws
Venturing onto foreign turf, White then commented briefly on the debate regarding fee-shifting bylaws. (See this Cooley Alert and this post.) White noted that Section 11(e) gives the court discretion to impose costs and attorneys’ fees against either party whose suit or defense is found to have been without merit, including in class actions. She also acknowledged that there have been calls for the SEC to intervene in some cases as an amicus.
(See, for example, this post discussing Professor John Coffee’s entreaty to the SEC to intercede in this issue, questioning why the SEC was “sitting on the sidelines.”
What is Coffee’s prescription for the SEC? Coffee suggests, unless the provision at issue expressly precluded application in cases involving the federal securities laws, that the SEC file amicus briefs in litigation arguing that these provisions are contrary to public policy as expressed in the federal securities laws and therefore any state law permitting them is preempted. (E.g., think indemnification.) In addition, he recommends that the SEC not grant acceleration of registration statements for companies the charters or bylaws of which contain onerous or punitive versions of fee-shifting provisions. To support his case, Coffee analogized to the SEC’s refusal to grant acceleration for entities that would require mandatory arbitration that is onerous or punitive. Notably, a more modest provision –one that comes into play at the motion-to-dismiss stage and would allow only a modest recovery — might be, in Coffee’s view, acceptable.)
Although White declined to comment on the merits of the arguments, she did acknowledge that “the SEC and courts have long recognized that the ability of shareholders to bring an action under the federal securities laws provides them with an important remedy that can complement our enforcement actions.” She also expressed concern “about any provision in the bylaws of a company that could inappropriately stifle shareholders’ ability to seek redress under the federal securities laws. All shareholders can benefit from these types of actions. If the Commission comes to believe that these provisions improperly hinder shareholders’ exercise of their rights, it may need to weigh in more directly in this discussion, as it did with indemnification under the Securities Act….” (Sounds like a comment to me, maybe even a warning.…)
Now, she explained, the staff is “focused on making sure the disclosures in company filings about its fee shifting provision — and the implications of such provisions — are clear. If a company chooses to adopt a fee-shifting provision, it should clearly communicate to shareholders the specific features of the provisions and its effect on shareholders’ ability to bring a claim. Shareholders should be fully informed of a company’s efforts to affect their ability to seek redress so that the issue can be considered in voting and investment decisions.”
In the end, White argues for more constructive and responsible behavior, a more balanced and open-minded approach, in short, less gamesmanship:
“What I have been advocating a bit today is a more open, constructive and balanced approach between companies and their shareholders. Companies should continue toward greater engagement with their owners, and carefully listen to their views. Activists should act responsibly and according to the rules. The strategic creativity of lawyers on either side may not always best serve the public interest. Upending the traditional roles of management, boards, and shareholders should not be the objective. Companies need their management and boards focused on their ‘jobs’ so they can deliver shareholder value and contribute to the economic growth and innovation on which our country has always depended. But resisting all change, stonewalling every overture or ignoring the views of shareholders is also not acceptable or productive. Constructive engagement should be everyone’s goal.”
