Here is analysis from ISS’s Ted Allen:
During the 2011 U.S. proxy season, investors again will see a significant number of shareholder proposals that address corporate takeover defenses, such as supermajority voting requirements, classified boards, and limits on shareholder-called special meetings.
Once again, most of these resolutions have been submitted by California shareholder activist John Chevedden and other affiliated investors. So far, shareholders have filed 166 proposals that target takeover defenses, which account for 43 percent of the 386 governance proposals tracked by ISS this year. By contrast, investors have submitted 120 proposals on board issues (such as majority voting and independent chairs), and just 55 resolutions on compensation topics.
So far, investors have filed 48 proposals that urge companies to allow investors holding a certain minimum stake (such as 10 percent) to call a special meeting. However, 12 companies have obtained permission from the Securities and Exchange Commission under Rule 14a-8(i)(9) to omit these proposals by offering their own management proposals with higher ownership thresholds (such as 25 or 40 percent) and other limits on special meetings. Allstate, FirstEnergy, and YUM! Brands are among the issuers that have successfully argued that shareholder proposals would conflict with their management resolutions. In addition, Mattel and Waste Management have told the SEC that they plan to add one-year net-long position requirements to their management proposals.
These companies assert that a higher ownership hurdle is necessary given the expense and distraction of holding a special meeting. While activists would prefer lower thresholds, 53.8 percent of S&P 500 firms do not provide the right to call special meetings, according to ISS GRId data. Another 14.4 percent have ownership thresholds under 25 percent, 14.8 percent require between a 25 and 49 percent stake, and 17 percent have a 50 percent or greater standard.
So far, special meeting proposals have survived no-action challenges on eligibility or other grounds at Honeywell, General Dynamics, AT&T, American Express, and Verizon Communications. As of March 9, 31 proposals on this topic were still pending. It remains to be seen whether these proposals will fare better than last year, when the average support fell to 43 percent, down from 50.1 percent in 2009.
Meanwhile, Chevedden and other retail investors again are filing a greater number of resolutions that urge companies to allow a majority of investors to act by written consent. ISS is tracking 40 proposals this year, up from 29 in 2010. So far this season, 16 companies have asked the SEC for permission to exclude these proposals, but just one request (from Bank of America) has been granted.
Last year, written consent proposals, which appeared on 2010 proxy statements after more than a decade absence, averaged a surprising 54 percent support, but these resolutions may not fare as well this season as some institutional investors have revised their voting guidelines to consider other governance factors, such as a company’s threshold for calling special meetings. About 30 percent of S&P 500 firms now allow investors to act by written consent, ISS data shows.
Supermajority Voting Rules
Investors also will see a significant number of proposals from retail activists that seek to repeal the supermajority (such as 80 or 66 percent) voting rules that some companies have for bylaws or other agenda items. ISS is tracking 35 of these proposals this year; but 20 face no-action challenges. This topic averaged more than 73 percent support, the highest support level for a shareholder measure in 2010, and had 70.5 percent approval in 2009. Notwithstanding these votes, supermajority rules remain common; 55 percent of S&P 500 companies have such rules, according to ISS GRId data.
In a new development since last spring, companies are successfully using Rule 14a-8(i)(9) to exclude these proposals. In most cases, management seeks to propose a majority-of shares-outstanding threshold, while the activists are asking the companies to adopt a majority-of-votes-cast standard. Del Monte Foods successfully used this argument to omit a supermajority proposal filed for its September 2010 meeting. Since then, Alcoa, Medco Health Solutions, Fluor, and three other issuers have used this approach to exclude 2011 proposals on this topic. Four other proposals have been omitted on other grounds. Prudential Financial sought to exclude this resolution based on insufficient proof of ownership, but was turned down. Twenty-two proposals remain pending.
Board Declassification
Another widely supported reform is board declassification, which averaged 58 percent support in 2010. So far, ISS is tracking 34 proposals for 2011. The Nathan Cummings Foundation has filed at least 11 of these resolutions that seek annual elections for all directors. Other proponents include the American Federation of State, County, and Municipal Employees (AFSCME); the Florida State Board of Administration; New York City’s pension funds; and retail investors affiliated with Chevedden.
So far, Allergan, Dun & Bradstreet, DirecTV, and three other issuers have obtained permission to exclude these resolutions by arguing that they had substantially implemented them. The Nathan Cummings Foundation has withdrawn five proposals, typically after the companies agreed to declassify. Meanwhile, KBR has sued Chevedden in federal court over a declassification proposal and contends that he failed to provide sufficient proof of ownership.
In addition, AFSCME has asked Ball Corp. and Wellpoint to reincorporate to Delaware from Indiana, where a 2009 state law requires staggered board terms unless a company’s board votes to opt out.
Oklahoma-incoporated firms may be a target of similar proposals in the future. In September, a new Oklahoma corporate law took effect that mandates classified boards; to opt out, a company would have to wait until 2015 and then obtain support from a majority of shares outstanding. John Keenan, a strategic analyst with AFSCME, said the union pension fund has no immediate plans to file reincorporation proposals at Oklahoma firms, but noted: “we’ll continue to evaluate the changes and overall corporate governance regime of Oklahoma law.”
Classified boards have received more attention in recent months after a trio of Delaware court decisions upheld poison pills at Airgas, Selectica, and Borders Group, which all had staggered board terms. In a recent Wall Street Journal commentary on the Airgas decision, Harvard Law Professor Lucian Bebchuk observed that a declassified board can be an “antidote” to a poison pill. “Despite the Delaware court’s decision, investors still have recourse–because a poison pill is powerful only as long as the directors supporting it remain in place,” Bebchuk wrote. “If, by contrast, a company’s shareholders could replace a majority of its board more quickly, the board’s power to block a takeover bid would be correspondingly weakened.”
Overall, U.S. companies have responded to shareholder demands for this reform in recent years. Within the S&P 500 index, 61.6 percent of companies now have declassified boards, and another 6.2 percent are in the process of eliminating their staggered board terms, according to ISS GRId data.
Investors also have filed a handful of proposals that address other takeover defenses. Retail investors have asked Ford Motor, Martha Stewart Living Omnimedia, Telephone & Data Systems, Constellation Brands, and Ingles Market to drop their dual-class equity structures, while Comcast was allowed to omit a recapitalization proposal on ownership grounds.
The Amalgamated Bank’s LongView Fund filled a proposal at J.C. Penney that asked for a shareholder vote on its poison pill, but that resolution was withdrawn after the retailer announced new board appointees. While activists no longer submit dozens of pill proposals each season, investors still care about this issue. In 2010, the failure to seek shareholder approval for a poison pill contributed to majority withhold votes against directors at least seven Russell 3000 companies.
In what may reflect a new trend following the Del Monte hearing and decision, plaintiffs in this recent complaint allege that a financial advisor aided and abetted breaches of fiduciary duties by their client’s board. Specifically, plaintiffs allege that BofA Merrill Lynch “knew that the Emergency Medical Services Board actually disregarded its fiduciary duty to evaluate what is in the best interest of the company and its shareholders, and determined to pursue a singular strategy – to sell the Company” and that BofA Merrill Lynch aided and abetted the directors’ breach of fiduciary duty by “persuading the Board to accept the negative premium Proposed Transaction, to ensure BAML’s receipt of lucrative advisory and financing fees.”
In the EMS transaction, BofA Merrill Lynch and Goldman Sachs were co-financial advisors. BofA Merrill Lynch, which, at the Board’s request, was offering to provide buyer financing, did not render a fairness opinion. Goldman Sachs, which was not offering to provide buyer financing, rendered a fairness opinion.
Note that the complaint merely reflects plaintiffs’ allegations and not a judicial determination of fact. The disclosure in the proxy statement give some indication of some of the defenses likely to be raised, such as these extracts:
Background of the Merger
In order to enhance the confidentiality of the process by reducing the number of financial institutions involved before the board of directors determined whether to proceed with a formal sale process, the board of directors determined not to allow potential purchasers to disclose information to possible equity or debt financing sources. Rather, the board of directors requested that BofA Merrill Lynch provide potential purchasers with its preliminary views as to the possible financing for an acquisition and, if requested by qualified purchasers, to arrange and/or provide for such financing (however, potential purchasers were advised that they would not be required to use BofA Merrill Lynch financing for any transaction). Subsequent to this meeting, the Company provided its written consent to BofA Merrill Lynch and its affiliates serving as a potential source of debt financing, if requested by qualified purchasers, which consent outlined certain information and communication barriers that would be put in place between BofA Merrill Lynch’s financial advisory team providing services to the Company and the bank’s financing teams that would be established in connection with potential financing to qualified purchasers.
[. . . ]
On December 1 and 2, 2010, a first round process letter with invitations for submission of indications of interest was sent to potential purchasers. The letter instructed potential purchasers to base their indications of interest on a financing structure proposed by BofA Merrill Lynch. The letter stated that potential purchasers were not required to use BofA Merrill Lynch financing for an acquisition of the Company and would have the opportunity to work with other sources of financing in preparing final bids.
[. . . ]
On February 4, 2011, bids were received from CD&R and Party B. The CD&R bid proposed a purchase price of $63.00 per share and was accompanied by specific proposed changes to the merger agreement and unitholders agreement, and proposed forms of limited guarantee, equity commitment letter and debt financing commitments. As anticipated and authorized by the board of directors, CD&R’s debt financing commitment letter contemplated the participation of BofA Merrill Lynch and certain of its affiliates in the proposed debt financing for the merger as one of six potential debt financing sources.
Engagement of Merrill Lynch, Pierce, Fenner & Smith Incorporated
As further discussed above (see “–Background of the Merger”), the Company retained BofA Merrill Lynch as one of its financial advisors in connection with the merger. In addition, BofA Merrill Lynch and certain of its affiliates will provide a portion of the debt financing for the merger, subject to specified conditions as set forth under “–Financing of the Merger–Debt Financing.” Given that BofA Merrill Lynch and certain of its affiliates had been requested by the Company to arrange and/or provide, and ultimately participated in, the debt financing for the merger, BofA Merrill Lynch was not requested to, and it did not, deliver an opinion in connection with the merger.
In connection with BofA Merrill Lynch’s services as the Company’s financial advisor, the Company has agreed to pay BofA Merrill Lynch an aggregate fee currently estimated to be approximately $12.95 million, $500,000 of which was payable upon execution of the merger agreement and the balance of which is payable upon completion of the merger. The Company also has agreed to reimburse BofA Merrill Lynch for its reasonable expenses, including fees and disbursements of BofA Merrill Lynch’s counsel, incurred in connection with BofA Merrill Lynch’s engagement and to indemnify BofA Merrill Lynch, any controlling person of BofA Merrill Lynch and each of their respective directors, officers, employees, agents and affiliates against certain liabilities, including liabilities under the federal securities laws, arising out of BofA Merrill Lynch’s engagement. BofA Merrill Lynch and its affiliates comprise a full service securities firm and commercial bank engaged in securities, commodities and derivatives trading, foreign exchange and other brokerage activities, and principal investing as well as providing investment, corporate and private banking, asset and investment management, financing and financial advisory services and other commercial services and products to a wide range of companies, governments and individuals.
In the ordinary course of business, BofA Merrill Lynch and its affiliates may invest on a principal basis or on behalf of customers or manage funds that invest, make or hold long or short positions, finance positions or trade or otherwise effect transactions in equity, debt or other securities or financial instruments (including derivatives, bank loans or other obligations) of the Company, CD&R, Onex and certain of their respective affiliates and/or portfolio companies. BofA Merrill Lynch and its affiliates in the past have provided, currently are providing, and in the future may provide, investment banking, commercial banking and other financial services to the Company, CD&R, Onex and/or certain of their respective affiliates and portfolio companies and have received or in the future may receive compensation for the rendering of these services.
Last week, Wachtell Lipton filed a rulemaking petition with the SEC regarding the beneficial ownership reporting rules found in Section 13(d) of the Securities Exchange Act of 1934. Although it’s becoming more common for NYC firms to submit comment letters on SEC proposals, it remains rare for one of those firms to submit a rulemaking petition. Here is an excerpt from Wachtell Lipton’s memo regarding the petition:
Our request highlights the urgent need to amend the existing reporting framework to keep pace with market realities and abuses, in particular by closing the Schedule 13D ten-day window between crossing the 5% disclosure threshold and the initial filing deadline, and adopting a broadened definition of “beneficial ownership” to fully encompass alternative ownership mechanisms. Recent maneuvers by activist investors both in the U.S. and abroad have demonstrated the extent to which current reporting gaps may be exploited, to the detriment of issuers, other investors, and the market as a whole.
The current ten-day window both deprives the investment community of material information and creates an opportunity for investors to engage in “stealth” acquisitions of significant positions to the detriment of their counterparties and issuers, and contrary to the purposes of the Williams Act. Accordingly, we recommend that the SEC require that the initial Schedule 13D filing be made within one business day following the crossing of the 5% ownership threshold, using the “prompt” disclosure standard that the SEC requires with respect to material amendments to existing Schedule 13D filings. In addition, in order to give time for the market and investors to assess Schedule 13D disclosures, we recommend that the SEC adopt a “cooling-off period” between the acquisition of 5% beneficial ownership until two business days after the initial Schedule 13D filing is made during which acquirers would be prohibited from acquiring additional beneficial ownership.
Furthermore, the current definition of “beneficial ownership” under the Section 13 reporting rules is out of date and overly narrow, permitting activists to acquire significant influence and control while evading the 13D reporting requirements. To close this gap, and to keep pace with current market practices and disclosure regimes in other developed financial markets, we recommend that the SEC adopt a broad definition encompassing ownership of any derivative instrument which includes the opportunity, directly or indirectly, to profit or share in any profit derived from any increase in the value of the subject security.
We believe that these actions are necessary to further the smooth functioning and transparency of the U.S. securities markets and restore investor confidence. We urge the SEC to take prompt action to modernize the Section 13 rules consistent with the new authority granted by the Dodd-Frank Act.
From Kevin Miller of Alston & Bird, a member of our Advisory Board:
On March 4th, the Delaware Chancery Court (VC Noble) issued an injunction prohibiting Atheros from holding a meeting of its stockholders to vote upon a merger agreement with Qualcomm pursuant to which Atheros would be acquired by Qualcomm for $3.1 billion in cash in In re: Atheros Communications. Based on a preliminary record, the Court enjoined the stockholder vote pending the distribution of curative disclosures regarding (i) the fees to be paid to Atheros’ financial advisor and (ii) the timing and extent of discussions with the President and CEO of Atheros with respect to his future employment by Qualcomm.
“Stockholders should know that their financial advisor, upon whom they are being asked to rely, stands to reap a large reward only if the transaction closes and, as a practical matter, only if the financial advisor renders a fairness opinion in favor of the transaction. . . .Defendants point out that contingent fees are customary. As set forth above, they are. Defendants argue that there is no magic contingent percentage that mandates something more than a disclosure that a “substantial portion” of the fee is contingent. Defendants are correct in this assertion as well. The Court, however, need not, in its current effort, draw any bright line. That fixing such a line might be difficult, if perhaps impossible, does not necessitate a conclusion that disclosure of the contingency percentage is always immaterial and of no concern. . . . coupled with the contingent fee concerns set forth above, the stockholders should be afforded an opportunity to understand fully the nature and means by which Atheros will compensate [its financial advisor]. Thus, that would include the amount of the fee as well.”
The Court rejected claims that the proxy statement relating to the merger contained material omissions regarding (i) the use of street forecasts rather than financial projections prepared internally by Atheros and (ii) the discount rate utilized in the discounted cash flow analysis performed by Atheros’ financial advisor. Here’s the proxy supplement.
“[Atheros’ financial advisor] decided that, under the methodology it employed, the internal projections were not useful because they would not allow for an “apples to apples” comparison with the information available for comparable transactions. Thus, it instead used only the Street Projections in its valuation analysis. The Plaintiffs may disagree with that decision, but, as the Court has observed, “[t]here are limitless opportunities for disagreement on the appropriate valuation methodologies to employ, as well as the appropriate inputs to deploy within those methodologies. Considering this reality, quibbles with a financial advisor’s work simply cannot be the basis of a disclosure claim.” [quoting In re 3Com]
The Court also rejected plaintiff’s request for an injunction based on allegations that the Board breached its fiduciary duties by implementing an inadequate sales process resulting in an unfair price.
“On the whole, there is nothing in the record to indicate that the Board acted unreasonably. It was an independent board with deep knowledge of the Company’s industry and it employed a robust and sophisticated process. As a result, the Court will not second-guess the Board’s conduct, and the Plaintiffs have failed to demonstrate any reasonable probability of success on the merits of their price and process claims.”