DealLawyers.com Blog

This recent study taps “social identity theory” to address how gender differences among directors impact the board’s decision-making in the M&A context. As further described in this article, social identity theory in the board setting is the notion that the board’s behavior is a function of how individual directors perceive others and themselves in the context of the board as a whole.

Minority directors such as women, who are perceived as outside of the majority’s “in-group,” will tend to actively distinguish themselves in board group interactions. The net effect on the board as a whole is a more robust and drawn out decision-making process – consistent with the theory that diverse groups generally (regardless of context) tend to make more thorough, comprehensive decisions.

Based on social identity theory, the study’s authors expected that boards with female representation would be less likely to approve proposed deals, and – even assuming deal approval – less likely to approve larger (i.e., riskier) deals. To test the theory, the study reviewed the association between women on boards and the number and size of aquisitions among over 1,500 S&P 500 companies between 1998 and 2010.

As predicted based on the theory, greater female representation on boards was negatively correlated with the number and size of acquisitions – i.e., companies with above average representation by women on the board were associated with 18% fewer acquisitions and a 12% decreased acquisition size compared to companies with below average female board representation.

While acknowledging the strong support of their hypothesis about how social identity theory impacts boardroom conduct, the authors appropriately caution that comprehensive board decision-making and oversight – characteristic of more diverse boards – may not, in and of itself, always be good. Among other things, the board’s behavior resulting from “in” (majority) and “out” (minority) group categorizations could be associated with undesirable consequences, such as reduced cohesion and increased “coordination” costs. See also this Insead article.

This blog entitled “If You’re Waiting for ISS, It Might Be Too Late” written from the activist investor viewpoint is interesting. Here’s an excerpt:

Problems With Waiting for ISS and GL
While support from ISS and GL certainly can’t hurt, it also is by no means assured, even in poor performers. In proxy contests, both firms render opinions based on two criteria:

– Is the company bad enough that the BoD needs change, and changing the BoD will matter?
– Will the shareholder nominees do better than incumbents?

If an investor can’t persuade institutions on these two points before ISS and GL render an opinion, an investor may not persuade ISS and GL, either. Even worse, ISS and GL have less influence than one might think. Most of the largest institutions have independent proxy departments that analyze proxy contests. ISS and GL have input to their decision, but hardly determine how they vote.

Why Is It Even Close?
We prefer activist projects at portfolio companies with big problems, obvious solutions, and a concentrated institutional investor base. Who wouldn’t? There, it becomes straightforward to convince other shareholders of the case for change, and that your BoD nominees make more sense.

Obviously, not every company fits. Many situations can get close. The less it fits, the more a shareholder dependson ISS and GL to help make the case. As you depend more on ISS and GL, you lower the chances of prevailing. Worry about ISS and GL, especially if you can’t avoid a close situation. But, try not to count on them.

Here’s this thought piece from Tom Bayliss and Mark Mixon of Abrams & Bayliss:

If it becomes law, Delaware State Senate Bill 75 will prohibit Delaware stock corporations from adopting provisions in their bylaws or certificates of incorporation that would shift legal fees to the losing party in stockholder litigation. The debate over these so-called “loser pays” provisions and the proposed legislation prohibiting them has generated controversy nationwide. Opponents of the legislation argue that abusive lawsuits impose a “merger tax” and that prohibiting “loser pays” provisions would “eliminate an important mechanism” that could “protect innocent shareholders against the costs of abusive litigation.” Proponents of the legislation contend that “loser pays” provisions would “foreclose meritorious stockholder claims [and] render illusory the fiduciary obligations of corporate directors.” Both sides of the public debate have overlooked the availability of “no pay” provisions, which could transform stockholder litigation without the effects that make “loser pays” provisions unpalatable to many.

In its simplest form, a “no pay” provision requires each side to bear its own fees and costs in stockholder litigation, unless the court concludes that one side litigated in bad faith. Policymakers, practitioners and academics should consider “no pay” provisions as both a tool to address the recent torrent of stockholder litigation and potentially the next battleground if Delaware’s legislature prohibits “loser pays” provisions.

First, “no pay” provisions are important because they could restore the so-called “American Rule” to a critical type of stockholder litigation. The American Rule has been a fixture of the legal landscape in the United States since its inception. But a stockholder suit challenging a transaction that settles in exchange for the issuance of supplemental disclosures falls within the “corporate benefit” exception to the American Rule. Under this exception, the reviewing court awards the plaintiff’s attorney a fee (to be paid by the corporation) for obtaining a “benefit” for the corporation’s stockholders. Because the average fee award for a disclosure settlement is approximately $500,000, the prospect of this type of fee award subsidizes shot-in-the-dark claims by lawyers representing stockholders who do not internalize the cost of authorizing an attorney to bring suit against the corporation. “No pay” provisions applicable to class action litigation that settles for disclosures would restore the American Rule to this key type of stockholder litigation by requiring each side to bear its own fees and costs. This would fundamentally change the economics of the decision to file suit, because weak suits that could only generate a disclosure settlement would no longer be profitable for lawyers to prosecute on a contingent fee basis.

Second, “no pay” provisions lack the most problematic characteristic of “loser pays” provisions. “Loser pays” provisions threaten to impose significant costs on stockholder plaintiffs who are unsuccessful. Critics of “loser pays” provisions argue that the potential imposition of these costs on stockholder plaintiffs would reverse the limited liability structure of the corporate form by imposing the debts of the corporation (and potentially related parties) on one or more of the corporation’s stockholders. These critics also argue that that the potential imposition of millions of dollars in defense costs would chill even meritorious claims and effectively bar the courthouse door to small stockholders. By contrast, “no pay” provisions would simply eliminate the profitability of pursuing a suit that settles for specified benefits (perhaps disclosures or other non-monetary benefits), unless the stockholder plaintiffs have agreed to pay their attorneys.

Third, “no pay” provisions are endlessly scalable and could be crafted to apply only to specifically identified types of claims, forms of litigation or specific types of settlements. For example, a “no pay” provision could expressly permit fee-shifting if (a) the litigation achieves a monetary benefit for the corporation, (b) the litigation results in disclosures that exceed Delaware’s materiality threshold by a specified margin, or (c) a court determines that the non-monetary benefits obtained in the litigation exceed a specified dollar-equivalent value.

Fourth, if crafted to provide simply that each side shall bear its own fees and costs, “no pay” provisions would preserve the opportunity to seek fee awards from common fund recoveries in class actions, since the plaintiff class would be paying its own lawyers. This would be consistent with the American Rule’s fee-allocation regime. Plaintiffs’ lawyers might also retain the opportunity to seek fee awards for obtaining common fund recoveries and non-monetary, therapeutic benefits in derivative actions, since the corporation would be paying lawyers pursuing claims on the corporation’s behalf. Tailored in this way, “no pay” provisions would bite only in situations where a class action resulted in non-monetary benefits to a plaintiff class, and where the court would (absent a “no pay” provision) typically require the corporation to pay the fees of the lawyers representing the class in accordance with the “corporate benefit” doctrine.

Fifth, “no pay” provisions appear to be consistent with Delaware’s traditional approach to corporate governance, which favors private ordering within a framework imposed by a broadly enabling corporate statute and common law principles developed on a case-by-case basis under the leadership of Delaware’s judiciary. Even if Delaware’s legislature prohibits “loser pays” provisions, the Delaware Court of Chancery would retain the power to regulate “no pay” provisions in fact-specific circumstances.

Sixth, “no pay” provisions appear to be facially valid under Delaware law. On May 8, 2014, the Delaware Supreme Court rejected a facial challenge to the validity of a “loser pays” bylaw adopted by a Delaware non-stock corporation in ATP Tour, Inc. v. Deutscher Tennis Bund, 91 A.3d 554, 560 (Del. 2014). To the extent this holding applies to Delaware stock corporations, it suggests that “no pay” provisions would survive scrutiny. Critics would undoubtedly challenge “no pay” provisions as incompatible with the authority of the courts to shift fees pursuant to the “corporate benefit” doctrine. But the corporate benefit doctrine is a common law feature founded on public policy concerns arising out of the application of the American Rule in specific contexts. A reviewing court could easily find that the public policy benefits of permitting private ordering regarding attorneys’ fees among the parties to the corporate bargain, especially in a context where the volume of non-meritorious stockholder litigation raises basic questions about the legitimacy of Delaware’s system of corporate governance, outweighs the countervailing considerations. If one conceives of “no pay” provisions as embodying a decision by stockholders to waive the right to seek fees from the corporation for obtaining specific types of corporate benefits (and forgo the associated incentives), they seem difficult to challenge as fundamentally contrary to Delaware law.

For all of these reasons, “no pay” provisions deserve far more attention from policymakers, practitioners, and academics than they have received to date. They could easily become a critical tool for regulating stockholder litigation. If Delaware’s legislature prohibits “loser pays” provisions, “no pay” provisions could also become the next battleground between the antagonists in the current debate over fee-shifting.

Here’s an excerpt from this blog by Lane Powell’s Doug Greene:

What’s the harm with taking a shot at as many fixes as possible?

Even if someone could see the big picture well enough to judge that these problems aren’t sufficient to outweigh the benefits of fee-shifting and minimum-stake bylaws, I would still hesitate to advocate their widespread adoption, because governments and shareholder advocacy groups would step in to regulate under-regulation caused by reduced shareholder litigation. That would create an uncertain governance environment, and quite probably a worse one for companies. Fear of an inferior alternative was my basic concern about the prospect that the Supreme Court in Halliburton Co. v. Erica P. John Fund, Inc. would overrule Basic v. Levinson and effectively abolish securities class actions.

Beyond the concern about an inferior replacement system, I worry about doing away with the benefits shareholders and plaintiffs’ lawyers provide, albeit at a cost. Shareholders and plaintiffs’ lawyers are mostly-rational economic actors who play key roles in our system of disclosure and governance; the threat of liability, or even the hassle of being sued, promotes good disclosure and governance decisions. Even notorious officer and director liability decisions, such as the landmark 1985 Delaware Supreme Court decision in Smith v. Van Gorkom, are unfortunate for the defendants involved but do improve governance and disclosure.

For RBC v Jervis, the opening brief of RBC seeking reversal of Rural/Metro was filed last week in the Delaware Chancery Court. According to the scheduling order:

1. RBC’s Opening Brief may be up to 70 pages long and is due on or before May 19, 2015

2. Plaintiffs Answering/Opening Brief may be up to 85 pages long and is due on or before July 20, 2015

3. RBC’s Reply/Answering Brief may be up to 45 pages long and is due on or before August 31, 2015

4. Plaintiffs Reply Brief may be up to 20 pages long and is due on or before September 11, 2015

5. Oral argument has been scheduled for September 30, 2015

A few days ago, I blogged about these law firm memos describing the end result of Trian’s attempt on DuPont. Here’s an excerpt of this blog from “The Activist Investor” looking at it from the activist’s perspective:

Eye on the prize – Trian actually won: Most accounts that pick winners and losers deem Dupont the winner. Yet, as of this week, Trian gained around $200 million on its shares, which includes a 6% loss after Dupont announced the outcome last week. That’s about 15% on its investment, not what Trian wants (it pegs Dupont at $125/share, up from $70 today) but only a “loss” if we think in terms of BoD seats.

Don’t count on ISS and Glass Lewis: The major proxy advisors supported Trian. A handful of major institutional investors ignored this, and individual investors don’t know or care. These two groups decided the vote.

Avoid situations with large individual investor holdings: Individual investors own over 30% of Dupont shares. Reportedly, most voted against Trian. In most situations, companies start with the trust of these shareholders, and have decided advantages in communicating with them.

Institutions may not trust activist investors: Several major institutions voted against Trian, including BlackRock, Vanguard, State Street, and CalPERS. These sophisticated firms can discern how Dupont underperformed its peers. Trian also wanted only four out of twelve BoD positions, so it didn’t ask for much. It seems at least a few institutions continue to view activist investors as short-term opportunists.

Simplify the thesis: Trian took on a complicated job. It needed to persuade shareholders that Dupont has underperformed, and that its plan to break up the company would rectify that underperformance. Dupont did beat the S&P 500 (but not its peers), and argued credibly that its conglomerate structure makes sense. The endless SEC filings, letters, white papers, presentations, and news releases only led shareholders deeper into the weeds. A complex thesis makes suspicious institutional investors more skeptical, and confuses low-information individual investors with short attention spans.

A good settlement is worth it: Trian could have accepted a couple of BoD positions, not including Nelson Peltz. Trian needed Peltz to gain a BoD seat. Other investors likely would not care whether Trian wins four seats and includes Peltz, or settles for two that do not. Either are better than no seats, as the 6% share price decline demonstrates.

Smaller companies know less: Big corporations like Dupont can retain the best advisors, and have knowledgable directors that can deal cleverly with activist investors. Smaller companies lack these resources, and make for a fairer contest.

Most of all, the vote at Dupont does not represent a significant milestone in activist investing. No turning point here, no more or less than other activist situations involving iconic companies and impatient investors. As long as portfolio companies have entrenched, lazy, deceitful, or inept management and BoDs, we activist investors will continue to “win” and “lose” proxy contests, and BoD seats, and debates over balance sheets, operations, and strategy.

Here’s an excerpt from this Fried Frank memo (also see these other memos about the case):

In a move consistent with the Delaware courts’ recent general inclination for early dismissal of M&A-related litigation, the Delaware Supreme Court recently reversed the Chancery Court’s 2014 holding in Cornerstone. As a result of the Supreme Court decision, where a plaintiff seeks monetary damages for alleged breaches of fiduciary duty by disinterested, independent directors who are protected by an exculpatory charter provision, the plaintiff must sufficiently plead non-exculpated claims (i.e., claims for duty of loyalty violations) in order to survive a motion to dismiss—regardless of the judicial standard of review that applies to the board’s conduct.

Here’s the news from this Sullivan & Cromwell memo (also see this Jones Day memo):

On May 13, 2015, E. I. du Pont de Nemours and Company, a major chemical company with a market cap of approximately $68 billion, defeated a proxy campaign run by Trian Fund Management, L.P., the activist fund led by Nelson Peltz that owns approximately 2.7% of DuPont. Trian was seeking four seats on DuPont’s board of directors. DuPont announced this morning that all 12 of its incumbent directors were reelected at DuPont’s annual meeting of shareholders. Although the two most influential proxy advisory firms, Institutional Shareholder Services Inc. and Glass Lewis & Co., both supported Trian’s slate of director nominees, DuPont’s three largest institutional shareholders, The Vanguard Group, Blackrock, Inc. and State Street Corporation, all voted in favor of DuPont’s slate.

DuPont’s victory shows that boards and management teams who present a clear case that their business strategy will create superior value over a near- to medium-term time horizon can prevail over activist investors and over the proxy advisory firms’ tendency to recommend in favor of at least some of an activist’s nominees. As at DuPont, this can sometimes be accomplished through better articulation of the projected long-term effects of a company’s existing strategy.

DuPont’s win reinforces that activists, even those as influential as Peltz, will face challenges if they target companies with strong boards and management teams that have outperformed the market. DuPont’s victory may encourage outperforming large-cap companies to fight for a complete victory in activist situations rather than agreeing to settle with the activist. However, in order to take that approach and ultimately be successful, the company must have proactive and consistent engagement with its institutional shareholders, who increasingly make voting decisions in proxy contests independently from the proxy advisory firms and who are demonstrating a willingness to support companies that take investor engagement seriously and have proven responsive to shareholder concerns. It is also important to note that DuPont has an unusually large retail shareholder base, accounting for approximately 33% of its shares, and that retail investors have historically been supportive of management in proxy contests.

While the lessons from the DuPont/Trian proxy contest are indeed significant, it is always important to avoid generalizations since all proxy contests involve idiosyncratic factors and investors vote on a case-by-case basis.

If you also read my blog over on TheCorporateCounsel.net, then you know I dig fake SEC filings. As noted in this blog last year on the topic, they tend to be one of my most popular types of blogs. So yesterday was Christmas for me as this fake Schedule TO about a $8 billion takeover bid caused a stir and caused Avon’s stock to tank (see this DealBook piece).

This latest incident is a cautionary tale for investors as it’s not the first fake takeover announcement. My favorite dates back to 2001, as noted in this piece, when a fake “blank check” company calling itself “Toks Inc.” filed a Form SB-2 with the SEC announcing plans to take over General Motors, General Electric, AT&T, Hughes Electronics, AT&T Wireless, AOL Time Warner and Marriot International – for roughly $2 trillion in “Toks” stock. The promoter – Ade O. Ogunjobi – didn’t give up even when the SEC issued a “Stop Order” to prevent the registration statement from going effective and suing him for selling unregistered securities, later launching a website to promote his wild ambitions and plans to then hold press conferences to announce his plans for these major US companies he was to take over!

Hard to believe, but those SEC filings by Toks are still on EDGAR. Here’s my blog on “Fake Filings: How Do They Sneak a Form ID Past the SEC?” (scroll down)…

Nelson Peltz certainly is in the news after losing his battle with DuPont. Here’s an excerpt from this interesting blog by “The Activist Investor”:

Peltz started small, and got bigger. For the first five years, the market cap of his activist investments averaged $5 billion, with companies as small as Cheesecake Factory ($1.5 billion). That average excludes Kraft, with a $56 billion market cap. Since then, the market cap of his activist investments averaged $52 billion, which includes PepsiCo at $125 billion. He starts with smaller investments that he holds for awhile without any activist intent. He then adds to the position as the activist strategy takes shape. Dupont first showed up on Trian’s roster on June 30, 2013 with $300 million. He now has $1.8 billion in shares.

Trian has Form 13D filings on 8 of the 16 companies, so it eventually gets to at least 5% of outstanding shares. There, he has credibility with other shareholders, and influence with management. With almost $10 billion in assets, and the need to research and work on a limited number of companies, he invests in companies with an average market cap of $52 billion.

Michael Levin – the force behind “The Activist Investor” – subsequently sent around this note from one of his readers:

In your blog post, you pose the question as to why Peltz would want to go on the board of DuPont. While I think your comments regarding this are correct, I would suggest that there is more to it and that this would be applicable to any board role that he [or anyone – MRL] seeks. Peltz, like the best private equity guys, deeply understands the value creation process unlike the vast majority of individuals who serve on corporate boards. In that sense, he can bring, as do the other more successful activists, a level of both general value creation skill/focus and as importantly, discipline, to the board that is undoubtedly absent from not only the boards of companies that he targets but also, in my view, from the majority of public company boards.

I have restructured a number of underperforming company boards. One criteria I always seek is an individual who comes from the private equity (or even mezzanine lender) world in order to ensure that this general value creation mindset and skill is present in at least one other director besides myself. For the same reason, I believe Peltz seeks a board seat at target companies even when he may not have the experience with chemicals that he has with food. That said, the degree of analysis and research that Trian does on target companies does equip Peltz, Garden and any other nominee they may have with an in-depth and value creation oriented grasp of the company that is lacking in the incumbent board members (until they read a Trian white paper).