May 16, 2006

Investors File Fewer Pill Proposals

From ISS’ “Friday Report“: While more large U.S. companies are dropping “poison pills” and investor support for mandating a shareholder vote on such takeover defenses remains strong, the number of shareholder proposals on this topic has declined significantly, according to a recent ISS report.

However, that trend may change next year. A recent Securities and Exchange Commission (SEC) ruling may prompt more shareholders next year to seek bylaw amendments to require an investor vote on pills. In addition, a Delaware court ruling may inspire some investors to press again to encourage companies to seek shareholder approval before adopting a poison pill. Among S&P 500 companies, 46 percent had a poison pill defense at the end of 2005, down from 53.8 percent in 2004, according to the 2006 Background Report on Poison Pills at U.S. Companies by ISS’ Governance Research Service. Among the prominent firms that abandoned their pills last year were the Bank of New York, Caterpillar, McGraw-Hill, and Sempra Energy. The percentage of S&P 500 companies with such plans has declined steadily since 2002, when 60 percent had pills.

In 2005, voting support remained high for shareholder proposals concerning poison pills. (Typically, such proposals request that a company’s poison pill be redeemed or submitted for shareholder approval.) Seventeen of the 25 pill proposals that appeared on company ballots received majority support. Those 25 proposals received an average of 59.4 percent support, a slight decrease from the 61.1 percent average in 2004.

Despite this strong support, there has been a significant drop-off in the number of proposals filed. In 2004, 101 shareholder proposals were submitted (of which 52 came to a vote). Last year, 51 proposals were submitted (of which 25 came to a vote). ISS is currently tracking 29 proposal filings for 2006, of which 17 have either come to a vote or are expected to come to a vote.

SEC No-Action Rulings

The trend toward fewer proposals on poison pill issues may stem from SEC staff rulings in 2004 on “no-action” requests to omit proposals by companies that already have poison pill policies in place. Typically, such policies state that the company will obtain shareholder approval prior to the adoption of a poison pill or, in the event the company adopts a pill without shareholder approval, that the company will seek such approval within 12 months or at the next annual meeting. Nevertheless, investor opponents of poison pills argue that such policies allow companies the same discretion to adopt a pill without prior shareholder approval that the company had before the adoption of the policy.

In 2004, the SEC’s Division of Corporation Finance granted no-action relief to a number of companies that did not have a poison pill in place but that did have a policy on poison pills. The SEC typically concluded that the company had “substantially implemented” the shareholder proposal because of the existence of the company’s policy on poison pills. As a result, the SEC in 2004 allowed companies to exclude 24 of the 101 poison pill proposals filed by investors. The combination of these SEC rulings in 2004 and the decline in pill proposals in 2005 and 2006 suggests that shareholders may have viewed proposals at certain companies as futile efforts.

In early 2006, however, the SEC staff denied no-action relief to Electronic Data Systems (EDS) and a number of companies that have poison pill policies. At several of these companies, the SEC had permitted exclusion of pill proposals in 2005. The 2006 proposals differed from earlier proposals in that they included a request that the company amend its charter or bylaws to incorporate the proposal “if practicable.” In early March, the SEC reportedly reversed its position after several companies requested reconsideration. In the case of EDS, it was reported that the SEC ruled, “We note that there is a substantive distinction between a proposal that seeks a policy and a proposal that seeks a bylaw or charter amendment. In this regard, however, we further note that the action contemplated by the subject proposal is qualified by the phrase ‘if practicable’ and that the company has otherwise substantially implemented the proposal.”

Thus, while such proposals were excluded this year, the SEC staff rulings suggest that a future poison pill proposal that requests a charter or bylaw amendment likely would not be excluded, as long as the proponent does not use the objectionable phrase “if practicable.” Cornish Hitchcock, a lawyer who represents shareholder proponents including union pension funds and other institutional investors, said he was “surprised the SEC took that position on the ‘if practicable’ language but that this is something that should be addressed by proponents next year.”

Significant Delaware Court Ruling

Another important development regarding poison pills was the December 2005 ruling by Chancellor William Chandler of the Delaware Court of Chancery in the Unisuper Ltd. v. News Corp. litigation. The court ruled that Delaware law does not require that a poison pill policy contain a “fiduciary out.”

The central issue in the case, whether a company policy on poison pills may be changed at will by directors, was held over for a trial. The plaintiffs argued that News Corp. made an enforceable promise in the form of its pill policy to persuade shareholders in 2004 to approve the company’s reincorporation from Australia to Delaware. (On April 6, investors announced that they had reached a settlement to the litigation, in which the company agreed to put its pill to a shareholder vote. For more details, see the April 7, 2006, issue of Governance Weekly.)

Prior to the court’s December 2005 decision, many companies had claimed that, under state law, they are prohibited from adopting a policy requiring prior shareholder approval for the adoption of a poison pill. Companies argued that their fiduciary duties required them to retain the option of adopting a pill without shareholder approval. Companies making such arguments relied on earlier case law holding that a current board may not take action that disables a future board from managing the company.

Chancellor Chandler rejected this reasoning in the context of poison pill policies. The court noted that these earlier cases had dealt with “ defensive measures that took power out of the hands of shareholders.” Such defensive measures are different from poison pill policies where “shareholders will make the decision for themselves whether to adopt a defensive measure or leave the corporation susceptible to takeover,” the chancellor noted. Chandler held that, “It makes no sense to argue that the News Corp. board somehow disabled its fiduciary duties to shareholders by agreeing to let the shareholders vote on whether to keep a poison pill in place.” The court further held that, “Fiduciary duties cannot be used to silence shareholders and prevent them from specifying what the corporate contract is to say. Shareholders should be permitted to fill a particular gap in the corporate contract if they wish to fill it.”