The ghosts of securities law past, present, and future seem to haunt the headlines lately. But proxy access is heralded as the issue most likely to bring a tectonic shift in the balance of power between shareholders and boards – and the boundary between federal and state authority in corporate governance. Many are concerned that the SEC’s access proposal will empower special interests to hijack corporate policy toward objectives threatening long-term wealth maximization. In this article, Marty Lipton outlines his concerns. I have an answer that significantly alters the dynamic.
I call it the Chinese Menu Ballot. I explore the idea briefly in an article entitled “Pandora’s Ballot Box, or a Proxy with Moxie?” The SEC’s proxy access proposal concerns shareholder nominations. It says nothing about procedures to determine the winner of those elections. My method minimizes the ability of a small minority of highly interested, special interest shareholders to influence corporate elections. This danger is caused by the current plurality standard (most votes wins, even if not a majority) for contested elections.
The problem with plurality voting is that as more nominees appear on the ballot, the likelihood increases that a director not supported by a majority of voting shareholders will be able to win. And the number of nominees could be quite high. The SEC proposal limits individual shareholders from nominating more than a quarter of the total board size, but the presence of multiple shareholders nominating candidates could widen the field.
The reason why we don’t currently use majority voting for contested elections is that it may require a runoff, which would necessitate a second round of solicitations and double the expense. But my method alleviates the need for a runoff. A Chinese Menu Ballot would require a shareholder to rank the candidates in order of their preferences. The ballots would clearly state that any ballots that do not rank all candidates will be excluded. Then, any runoffs will be determined using the shareholders preferences to successively eliminate candidates in new vote tallies.
The result is very similar to what would happen if the company had a pure majority vote election with an actual runoff, and the result is significantly different from an election in which there are a large number of candidates and plurality voting is used. In each new round of a vote tally, the vote of a shareholder that voted for an eliminated candidate will be transferred to the next highest ranked candidate. And this transitive property of the Chinese Menu Ballot is the key to its ability to screen out special interest directors. The result is that candidates ranked high by a small number of shareholders, but not ranked within the top echelon by a majority of shareholders, are eliminated from the pool very quickly. Candidates ranked in the top echelon by a majority of shareholders will tend to emerge as winners.
There are a multitude of algorithms to use the shareholders’ rankings to generate an outcome. The appropriate method will depend upon circumstances particular to a company, including whether the board is staggered. The appropriate method will also depend on the demographics of a company’s shareholders, including the balance of institutional vs. retail investors and the type of institutional investors it has.
Consider a simple example: In the first round of vote tallying, each ballot’s vote will count toward the first ranked choice. After the first round of the tally, any seats not filled by a candidate receiving a majority of the votes will be determined by subsequent rounds of tallying. Before starting the second round of the tally, the candidate with the fewest number of votes (the candidate ranked first by the fewest number of shareholders) will be eliminated.
Any ballots that ranked the eliminated candidate first will now be registered as votes for their second ranked choice. This process would continue until the number of candidates remaining equals the number of available seats. There are a wide variety of available implementation methods and further recommendation would require a company-specific analysis.
For a brief analysis of the legality of this method under Delaware Corporate Law, I first note that DGCL 216 provides the plurality method as a default from which companies are free to opt-out via bylaw or charter amendment. And presuming that a company has the authority to amend the bylaws in its charter, it would be able to install this method unilaterally. In the unlikely event, however, that a company had a shareholder-adopted bylaw specifying the method for contested elections it would need to seek shareholder approval to implement this method.
I also do not think Chinese Menu Ballots would be subject to scrutiny under Blasius. Indeed, this method does not limit votes, it actually permits shareholders who voted for an eliminated candidate in one round to continue to have their vote counted in each successive round of the election. An analysis of this method under the federal proxy rules also indicates its legality. The Chinese Menu Ballot will need to include a space that permits withhold votes in accordance with Rule 14a-4(b)(2), but otherwise the proxy rules do not prohibit this method. I also note that this method would be difficult to implement, though not impossible, for companies that permit cumulative voting.
For assistance with implementing a Chinese Menu Ballot or other proxy access related issues, I am available for consultation.
Recently, the Ontario Securities Commission announced its reasons for its January ruling that led to the withdrawal of HudBay Minerals’ proposed acquisition of Lundlin Mining. In doing so, the OSC expressed concerns about potential conflicts of financial advisers who are compensated on the basis of the success of a transaction:
“[Contingent] fees create a financial incentive for an advisor to facilitate the successful completion of a transaction when the principal focus should be on the financial evaluation of the transaction from the perspective of shareholders. While the Commission does not regulate the preparation or use of fairness opinions, in our view, a fairness opinion prepared by a financial advisor who is being paid a signing fee or a success fee does not assist directors comprising a special committee of independent directors in demonstrating the due care they have taken in complying with their fiduciary duties in approving a transaction.”
The statement may signal an increased sensitivity by OSC to this issue – and call into question the ability of a board to rely on a fairness opinion where the financial advisor has a contingent fee arrangement. For more on this, see the related memos posted in our “Canadian M&A” Practice Area.
A few weeks ago, Delaware Vice Chancellor Lamb issued his opinion in San Antonio Fire & Police Pension Fund v. Amylin Pharmaceuticals that had challenged “poison puts” in debt agreements. The Court interpreted the fairly common “continuing director” provision in the indenture in a way that could have been expected, stating the board may approve as continuing directors persons nominated by dissident stockholders.
However, the Court did not rule – as not yet ripe – on the duty of good faith and fair dealing claim alleging the directors agreed to approve the dissidents here for purely self-interested reasons, but the Court suggested that the board must be fully informed about the inclusion of such provisions in debt instruments and might face a fairly high hurdle in justifying their agreeing to them. We have posted memos analyzing the opinion in our “Change-in-Control” Practice Area.
At Amylin’s annual meeting last week, dissident shareholders Carl Icahn and Eastbourne Capital each elected one director from their slate – thus avoiding triggering of the CIC provision at issue, as noted in this DealBook blog. We previously blogged about Icahn and Eastbourne’s unique no-action letters from the SEC to “round out” a short slate with other dissident’s nominees.
Some interesting news comes courtesy of Target, whose annual meeting is being held today. This will be no “regular” annual meeting as William Ackman, whose Pershing Square Capital Management owns a 7.8% stake, is seeking a seat for himself and four other nominees on Target’s board (as noted in this article) as well is seeking the company to use a “universal ballot” (as noted in The Corporate Library blog).
Although it’s become fairly common for dissidents in the throes of a proxy fight to leverage the Web (see this list of examples I have collected), it’s still fairly rare for companies to do the same. That’s why it’s worth noting Target’s annual meeting page to point out how they “get it” when it comes to campaigning online in their defense.
A number of the items posted on the company’s annual meeting home page were recommended in my article from the Spring ’08 issue InvestorRelationships.com entitled “The Coming Online IR Campaigns: The Future of Director Elections” (which is still available for free). To begin with, Target bothered to create an annual meeting home page. That’s a critical first step. They highlight endorsements from proxy advisors. They even post a white paper making their argument why they think one proxy advisor’s report is flawed (as noted in this article).
Have a good look. I predict these types of shareholder meeting sites will become more of the norm for IR departments/corporate secretaries when we live in a proxy access world without broker non-votes (ie. next year)…
You want further proof that the Web is changing the job of a corporate secretary? How about when a shareholder proponent posts a transcript of his remarks from the annual meeting? Governance guru Bob Monks did just that yesterday on his blog, right after he presented five proposals at Exxon-Mobil’s annual meeting.
Deal Protection: The Latest Developments in an Economic Tsunami
We have posted the transcript from our recent webcast: “Deal Protection: The Latest Developments in an Economic Tsunami.”
Last week, Corp Fin granted General Motors exemptive relief so that GM can move fast and exchange its debt. The relief is highly unusual, but certainly seems merited under the circumstances. GM has something like 26 series of debt outstanding, the federal government has lent the company billions under the TARP/TALF program – and pursuant to the terms of those loans, the company must restructure its debt (and operations) within a limited time period.
Therefore, GM had to commence its exchange offers immediately and begin soliciting consents to postpone the maturity dates. The two primary forms of relief granted by the Staff to GM include:
– Ability to solicit consents before a definitive proxy statement has been filed; and
– Ability to cut off withdrawal rights after 20 business days, but before the exchange offers necessarily expire.
I believe similar relief was granted to Chrysler back in the early ’80s under similar circumstances…
Spearheading the legal due diligence investigation of a potential acquisition target is a big part of a deal lawyer’s job. With the possible exception of preparing disclosure schedules, due diligence usually is the most tedious part of the transaction, but it is also among the most important. That’s why the “ready…FIRE!!!…aim” mindset that a deal’s time pressure sometimes causes lawyers to adopt when it comes to due diligence is almost always counterproductive.
Time is invariably of the essence in a transaction, so there is great pressure on everyone to get moving – particularly if you’re talking about a big deal with a mountain of paper to review and little time to do it. There’s an overwhelming temptation to wade into the pile and start reviewing things before you’ve figured out what the deal is about. This leads to a disorganized process that produces incomplete or incoherent results. That can make it very difficult for your client to make decisions about valuation in a timely fashion, and in a competitive situation, can be fatal to its efforts to acquire the target.
UCLA’s legendary basketball coach John Wooden had what I think is the best advice for anyone dealing with time pressure situations – “be quick, but don’t hurry.” What he meant by this is that when the pressure is on, you’ve got to move fast, but you’ve also got to remain in control of your situation. I think the best way to apply Coach Wooden’s advice to a deal with a short fuse is not to start your due diligence before you’ve done some due diligence.
No, I’m not trying to follow up John Wooden with advice that sounds like its coming from the mouth of Lakers’ coach Phil Jackson. What I’m talking about is spending some time at the front end to convert a scatter-shot approach to due diligence into a more disciplined preliminary assessment of the issues you’re likely to encounter. Investing time in laying the groundwork for your due diligence can make the investigation more efficient, less burdensome to both sides, and more effective overall.
How do you go about doing this? If you’re dealing with a public company target, then the first step should be to spend some time with the target’s SEC filings. Many of the documents that you’re going to want to review are going to be in those filings, but more importantly, a company’s SEC filings contain a wealth of other legal, financial and business information about the target that will be very useful to you in mapping out a strategy for approaching due diligence.
If you’re not dealing with a public company, chances are still pretty good that it competes with companies that are public, and their filings may provide you with a lot of help in focusing your initial due diligence efforts. SEC filings are also a good place to start if you’re not buying the company itself, but only a subsidiary or a division. If the business is large enough or represents a reportable segment, those filings will contain a remarkable amount of financial and other information about the business your client is looking to buy.
Chances are also pretty good that your client has managed to get a copy of an investment banker’s book on the target or some other form of offering document. That usually has lots of useful information about the business, although in order to get at it, you usually have to wade through a mountain of marketing spin and banker-speak (e.g., “management has proactively leveraged the company’s market leadership and value-added manufacturing expertise to position its new proprietary product to capitalize on the anticipated explosive growth in demand for…blah, blah, blah”). Research analyst reports on the target or its industry can also provide a wealth of information on the financial, business and even the legal issues confronting industry participants, and contain a lot less spin than the marketing materials typically do.
A lot of deal lawyers do everything I’ve just described as a matter of course, but sometimes what ends up happening due to the press of time is that the SEC filings, research reports and banker’s books end up getting thrown on the junior lawyers desks as “background” for that person to read as they wade through the data room. Most younger lawyers are smart people, but it isn’t reasonable to assume that they will necessarily pick up on the critical issues in the deal without some additional guidance. If you don’t give them that, you can almost count on them mindlessly regurgitating lease terms into a dictaphone without giving any thought to what they are doing. This is how useless 250 page due diligence memos are born.
I think a much better practice is to sit down with the legal due diligence team, the business people and the client’s financial advisor before turning the junior people loose on the data room. That way, you’ve got a shot at making sure that the people who will be reviewing the documents are aware of what the deal is all about, and what the critical legal issues that might affect valuation or the ability to complete the transaction are likely to be.
This effort to plan out due diligence may take a little more time than simply tossing a handful of associates into the deep end of the virtual data room, but it is guaranteed to produce a more efficient process in the long run and to generate results that are going to add a lot more value to the client.
In her first major public speech, new Assistant Attorney General for Antitrust Christine Varney announced last week that difficult economic times call for more aggressive – not less – antitrust enforcement and pledged the DOJ’s cooperation with other parts of the Executive Branch in pursuing reforms of numerous industries, including banking, healthcare, energy, telecommunications and transportation.
In addition, she announced that the DOJ’s Antitrust Division has withdrawn a controversial report issued last September under the Bush administration. The Report addressed single-firm conduct under Section 2 of the Sherman Act and has been widely viewed as applying legal standards that would make it difficult for the DOJ to bring new cases involving monopolization or predatory practices. Plenty of antitrust blogs have addressed this important speech; we have a list of those blogs in our “Antitrust” Practice Area.
This May-June issue of the Deal Lawyers print newsletter was just sent to the printer and includes articles on:
– Reversing Course: Delaware’s Supreme Court Provides Comfort to Directors Regarding Revlon Process and Bad Faith
– Going In-House: Stewart Landefeld On His Time at Washington Mutual
– The Shareholder Activist Corner: Mario Gabelli’s GAMCO
– Are We There Yet? Issuer Debt Tender Offers and Offering Period Requirements
– Private Equity in 2009: “Back to Basics” Practice Tips
If you’re not yet a subscriber, try a no-risk trial to get a non-blurred version of this issue for free.
In my last blog, I talked about some advice given to our firm’s associates during a training session on becoming a seasoned business lawyer conducted by two senior investment bankers from one of our firm’s clients. The first thing they mentioned was the importance of avoiding boorish first drafts. That piece of advice, together with many of the other suggestions they made about things that young lawyers should do or avoid doing, falls under the general heading of the need to be sensitive to the messages that your actions are going to send to the other people involved in the transaction.
You might think that a lot of this stuff would be intuitive, but it doesn’t appear to be that way for lawyers. For instance, one of the specific “don’ts” that our investment banker friends mentioned in their presentation was the seemingly obvious point of not making critical remarks to the client concerning its other advisors. Apparently, that’s something that some lawyers are notorious for doing. Unless your client’s retained Patrick Bateman as its financial advisor, that’s a very bad idea, if for no other reason than what goes around, comes around. Besides, while “plays well with other children” may not be a line item that appears on most law firm or corporate law department evaluation forms, it’s on most clients’ short list of the qualities that they look for in a deal lawyer.
Deal making by its very nature is a group effort, and the ability to work effectively in a transactional setting requires a skill that might be called “deal tact.” The best deal lawyers use this skill not only in their dealings with their own client and fellow advisors, but also in their dealings with those on the other side of the table, and particularly the lawyers who are representing the other side in the deal.
From time to time, I have had a chance to work on transactions with lawyers who have national reputations as M&A advisors. Although their styles differ markedly, deal tact is one quality that they have all shared in common. Let me give you an example of this that I’ve seen many times. During the early stages of the deal, draft documents are often hacked-up pretty significantly by the lawyers receiving them because, well, they sometimes just don’t make any sense. Incompetence or inexperience may be part of the reason for this, but far more frequently, it’s attributable at least in part to an unreasonable time schedule that requires somebody to generate a document before they know what the deal is about.
When this happens, there’s usually a younger lawyer on the deal team who is chomping at the bit to highlight each and every flaw in the document during the course of a negotiation session. This is understandable, since that kid pulled at least one all-nighter finding and correcting every last one of them. The superstar generally doesn’t let this happen. Instead, that lawyer typically will focus his or her attention on the major deal issues while clients are present. When the meeting is about to break-up, the mark-up will be passed on to the other side’s lawyers, usually accompanied by a statement noting that the mark-up includes some “lawyer comments” that aren’t worth wasting the group’s time on. That may be followed up with some sidebar discussions, but the important thing is that nobody loses face in front of their clients.
Now if you know anything about your fellow M&A practitioners, you know that it isn’t a saintly sense of humility that motivates this kind of conduct. Instead, it’s an appreciation for the fact that if you put somebody on the defensive, they’re going to do a couple of things. First, they’re going to try to defend themselves by quibbling with every point you make. Second, they will look for opportunities to stick it to you– and chances are pretty good that they’ll find at least one during the course of the transaction. Neither of these things moves the ball forward.
I’m not suggesting that deal lawyers should always act like Clark Kent — possessing a little deal tact doesn’t mean you shouldn’t play hard ball when appropriate. I’m just saying that Conan the Barbarian shouldn’t be our role model either. I mean, if you really believe that what is best in life is “to crush your enemies, to see them driven before you, and to hear the lamentation of their women,” you’d probably be much happier as a litigator anyway.
Every deal presents opportunities for a knowledgeable and experienced deal lawyer to grandstand in front of the client or make somebody on the other side look foolish in front of their client. One of the big things that separates the pros from the pretenders is the ability to resist that temptation in order to move the transaction forward.