Piet Mondrian, “Broadway Boogie Woogie” (1943)

Chapter 16 Public Shareholder Activism Piet Mondrian, “Broadway Boogie Woogie” (1943)

Module VI – Corporate Governance • Law of shareholder activism • Rational apathy: collective action problem • Changed calculus: institutional investors • State law: no-reimbursement rule • Federal law: shareholder communications • Shareholder proposal rule • Operation: SEC no-action • Proper proposals • Ordinary business exclusion • Proxy access Chapter 16Public Shareholder Activism Bar exam Corporate practice Theories of public corporation Berle-Means: separation of ownership and control Role of shareholders Manne: market for corporate control Easterbrook & Fischel: nexus of contracts Roe: political product Stout & Blair: team production Bainbridge: board-centric Law profession Citizen of world Chapter 16 Public Shareholder Activism

Review: shareholder voting • State law – minimal notice (capable of abuse) • Federal law (Securities Exchange Act of 1934) • Proxy card • Proxy statement (including executive comp) • Annual report • Federal proxy fraud cases (US Sup Ct) • Material misstatement • Reliance presumed • Causation shown if vote necessary for transaction • Court remedy includes rescissionary damages • State proxy fraud cases (Del Sup Ct) • Same elements as federal proxy fraud • Except reliance not presumed (class actions not possible)

Annual meeting (rite of spring) • Notice to record shareholders • Election of directors / approval of resolutions • Nominations at meeting • Proxy voting • Written appointment / authorization of agent • Revocable / limited duration: 11 months (MBCA) • Proxy solicitation • Distribution of proxy materials • Management uses corporate funds • Outsiders must use own funds • Proxy tabulation • Inspector of elections • Look over: signatures, delegated voting, dating of proxy Voting in Public Corporations Chapter 16 Public Shareholder Activism

“Shareholder democracy” “The American shareholder as a practical matter cannot nominate directors, he cannot remove them, he cannot – except at the arbitrary pleasure of the SEC – communicate advice to them. “Democracy is a cruelly misleading word to describe the situation of the American shareholder.“ Democracy: government by the people. Corpocracy: government by the corporation. Kleptocracy: government by corporate criminals. Robert Monks Corporations: A Contemporary Approach Chapter 16 Public Shareholder Activism Slide 5 of 65

Relation of ownership and control … Chapter 16 Public Shareholder Activism

Classic US corporation(unity of ownership and control) Capital Entrepreneur Equipment Supplies Adam Smith “Wealth of Nations” (1776) Land Labor Chapter 16 Public Shareholder Activism

Modern US corporation(separation of ownership and control) Capital (from diverse public investors) Professional manager Consumers Community Public Government Land Equipment Supplies Creditors Adolf Berle & Gardiner Means (1932) Corporations: A Contemporary Approach Chapter 16 Public Shareholder Activism Slide 8 of 65

1. Reformists (Berle & Means, Clark) 2. Contractarians – SH 1st (Easterbrook/Fischel, Manne) 3. Political realists (Roe, Miller & Macey) 4. “Team” theorists (Stout, Blair) 5. Contractarians - board 1st (Bainbridge) Law accepts separation. Shs let corporate boards mediate capital / mgmt / labor disputes Law fosters separation. Shs are disempowered by politics, which fears of concentrated money Separation is efficient. Shs protected by “control markets” / law should protect markets, scrutinize only “end period” tx Separation is anti-capitalist. Shs should have more disclosure rights + mgmt more fiduciary duties (offset mgmt power) Separation empowers board. Shs permit board to be Platonic guardians / law should minimize shareholder activism Pop quiz 1-D / 2-C / 3-B / 4-A / 5-E Chapter 16 Public Shareholder Activism

Group hypo Corporate voting You are the “voting committee” of Probity Investments, a large US mutual fund group. Your committee sets guidelines (and sometimes makes specific decisions) on voting shares in Probity’s equity portfolios. “Fund for the American Way” (FAW) is an activist investment pool that has targeted Bloated, Inc. for spending too much on community and social programs (symphonies, youth programs, art museums, adult learning, yecch). FAW plans to put 3 new directors on the seven-person Bloated board. FAW has solicited proxies from other institutional investors, including Probity – which owns 3.7% of Bloated. • What theory of corporate law (role of shareholders) should Probity follow? • How should Probity vote these shares? Milton Friedman Chapter 16 Public Shareholder Activism

Class Results 3 groups 2 – Y / 1 - N 10 groups 6 – Y / 4 - N 0 groups 0 – Y / 0 - N 2 groups 0 – Y / 2 - N 2 groups 0 – Y / 2 - N FAW fails to seat its anti-CSR directors Board as “team” mediator Contractarians (SWM) Contractarians (board primacy) Political Realists Reformists Board Centric Shareholder Centric Chapter 16 Public Shareholder Activism

Shareholder voting in public corporations Chapter 16 Public Shareholder Activism

Prisoner’s dilemma You have been arrested, along with your buddy. The police lead you to the interrogation room (separate from your partner), and lay out your options: You cannot cooperate with the other person. What do you do? Chapter 16 Public Shareholder Activism

You own GE stock and you’re convinced Immelt must go … Individual investor: 1,000 shares Institutional investor: 200 million shares (2%) Chapter 16 Public Shareholder Activism

Institutionalization(“deretailization”) • Investment companies • Mutual funds 27% • Hedge funds 3% • Pension funds • Private 9% • Public 14% • Banks (trust & estates) 0.5% • Insurance companies 8% • Securities firms 0.5% • State/local govt 0.8% • Endowment funds 1.5% • Foreign institutions 13% TOTAL (institutions) 77% Chapter 16 Public Shareholder Activism

Legal limits on shareholder activism … State reimbursement rule Federal limits on SH communications Chapter 16 Public Shareholder Activism

Rosenfeld v. Fairchild Engine & Airplane (N.Y. 1955) A spirited proxy fight results in a victory for the insurgents (highly unusual). Costs borne by corporation: $134,000 to defray incumbents’ expenses; $127,000 to defray insurgents’ (By the way, who approved these?) Shouldn’t each side bear their election-related costs? What is the rule on reimbursement of voting expenses? Why should incumbents be covered essentially always – but insurgents only if they win? Chapter 16 Public Shareholder Activism

State reimbursement rule NY Court of Appeals: In a contest over policy, as compared to a purely personal power contest, corporate directors have the right to make reasonable and proper expenditures [to overcome stockholder indifference and the difficulty of procuring a quorum] [Shareholder insurgents can] be reimbursed by the corporation for their expenditures … by affirmative vote of the stockholders. …. The stockholders … have the right to reimburse successful contestants for [their] reasonable and bona fide expenses Rosenfeld v. Fairchild Engine & Airplane (N.Y. 1955) NY Court of Appeals Chapter 16 Public Shareholder Activism

Long Island Lighting v. Barbash (2d Cir. 1985) LILCO's shareholders (and customers) are steamed. Management is committed to building a nuclear power plant (Shoreham), and the utility took its time to get power back after Hurricane Gloria. Matthews, a holder of 100 shares, starts a proxy fight. What does the SEC require he do? In addition, a "Steering Committee of Citizens to Replace LILCO" formed. It runs the following ad. What does management argue? Shoreham Nuclear Power Plant Chapter 16 Public Shareholder Activism

Replace LILCO More LILCO mismanagement: the utility wants to pass on to ratepayers the needless costs of building the Shoreham nuclear power plant. There's an alternative: sell LILCO to a public power authority. The utility would not have to pay dividends to shareholders. A Long Island Power Authority could buy cheap hydropower, reducing rates to LILCO ratepayers by up to 50%. State law guarantees the right to replace LILCO! Citizens to Replace LILCO Chapter 16 Public Shareholder Activism

Corporate “free speech”? Second Circuit: The question is whether the challenged communication is “reasonably calculated to influence the shareholders’ vote. [Remand to determine whether “Citizens to Replace LILCO” cooperating with Mathews proxy campaign] ****** Winter (dissent): It asks nothing less than that a federal court act as a censor, empowered to determine the truth or falsity of the ad. Chapter 16 Public Shareholder Activism

“Shareholder Communication” Rules • Rule 14a-3 • (f) The [proxy statement delivery requirements] shall not apply to … speeches in public forums, press releases, published or broadcast opinions, statements, or advertisements appearing in a broadcast media, newspaper, magazine or other bona fide publication …, provided that: • (1) No form of proxy, consent or authorization … is provided to a security holder in connection with the communication; and • (2) At the time the communication is made, a definitive proxy statement is on file with the Commission …. Rule 14a-2(b) [Proxy statement delivery requirements] ... do not apply to the following: (1) Any solicitation by ... any person who does not ... seek ... the power to act as proxy for a security holder and does not furnish or otherwise request ... a form of revocation, abstention, consent or authorization. Chapter 16 Public Shareholder Activism

Pop quizShareholder activism Chapter 16 Public Shareholder Activism

4. Shareholders who undertake a voting insurgency are reimbursed their expenses: • Under corporate bylaws • Only if successful • On same basis as management • 5. Public company institutional Shs that seek to vote out the board: • Can communicate freely – remember the 1st Amendment • Must abide by the proxy rules • Are exempt from the proxy rules • A hedge fund that places a WSJ ad opposing management • Violates the proxy rules • Is ok under the proxy rules, if it’s not soliciting votes • Is ok under the proxy rules, it it’s already filed a proxy statement • Shareholders are said to be “passive” because: • Collective action problems • Voting rights are limited • Management engages in voting manipulation • The institutionalization of US corporations refers to: • Corporate execs going to jail • Investments mostly managed by intermediaries • More shareholders than ever • The prisoner’s dilemma illustrates … • The value and difficulty of cooperation • How executives should avoid insider trading laws • The worthlessness of ISS Chapter 16 Public Shareholder Activism

Shareholder proposals Nature of Rule 14a-8 Procedure for submission / SEC review Grounds for exclusion Case studies: “say on pay” and “proxy access” Chapter 16 Public Shareholder Activism

Living with Sarbanes-Oxley THe Wall Street Journal (Oct 17, 2005) Chapter 16 Public Shareholder Activism

What is a shareholder proposal? Chapter 16 Public Shareholder Activism

What is a proposal? Who is eligible to submit a proposal, and how do I demonstrate to the company that I am eligible? How many proposals may I submit? How long can my proposal be? What is the deadline for submitting a proposal? What if I fail to follow one of the eligibility or procedural requirements explained in answers to Questions 1 through 4 of this section? If I have complied with the procedural requirements, on what other bases may a company rely to exclude my proposal? A shareholder proposal is your recommendation or requirement that the company and/or its board of directors take action, which you intend to present at a meeting of the company's shareholders. Shareholder proposal rule Chapter 16 Public Shareholder Activism

What is a proposal? Who is eligible to submit a proposal, and how do I demonstrate to the company that I am eligible? How many proposals may I submit? How long can my proposal be? What is the deadline for submitting a proposal? What if I fail to follow one of the eligibility or procedural requirements explained in answers to Questions 1 through 4 of this section? If I have complied with the procedural requirements, on what other bases may a company rely to exclude my proposal? In order to be eligible to submit a proposal, you must have continuously held at least $2,000 in market value, or I %, of the company's securities entitled to be voted on the proposal at the meeting for at least one year by the date you submit the proposal. You must continue to hold those securities through the date of the meeting. Shareholder proposal rule Chapter 16 Public Shareholder Activism

What is a proposal? Who is eligible to submit a proposal, and how do I demonstrate to the company that I am eligible? How many proposals may I submit? How long can my proposal be? What is the deadline for submitting a proposal? What if I fail to follow one of the eligibility or procedural requirements explained in answers to Questions 1 through 4 of this section? If I have complied with the procedural requirements, on what other bases may a company rely to exclude my proposal? Each shareholder may submit no more than one proposal to a company for a particular shareholders' meeting. Shareholder proposal rule Chapter 16 Public Shareholder Activism

What is a proposal? Who is eligible to submit a proposal, and how do I demonstrate to the company that I am eligible? How many proposals may I submit? How long can my proposal be? What is the deadline for submitting a proposal? What if I fail to follow one of the eligibility or procedural requirements explained in answers to Questions 1 through 4 of this section? If I have complied with the procedural requirements, on what other bases may a company rely to exclude my proposal? The proposal, including any accompanying supporting statement, may not exceed 500 words. Shareholder proposal rule Chapter 16 Public Shareholder Activism

What is a proposal? Who is eligible to submit a proposal, and how do I demonstrate to the company that I am eligible? How many proposals may I submit? How long can my proposal be? What is the deadline for submitting a proposal? What if I fail to follow one of the eligibility or procedural requirements explained in answers to Questions 1 through 4 of this section? If I have complied with the procedural requirements, on what other bases may a company rely to exclude my proposal? (1) If you are submitting your proposal for the company's annual meeting, you can in most cases find the deadline in last year's proxy statement. (2) The proposal must be received at the company's principal executive offices not less than 120 calendar days before the date of the company's proxy statement released to shareholders in connection with the previous year's annual meeting. Shareholder proposal rule Chapter 16 Public Shareholder Activism

What is a proposal? Who is eligible to submit a proposal, and how do I demonstrate to the company that I am eligible? How many proposals may I submit? How long can my proposal be? What is the deadline for submitting a proposal? What if I fail to follow one of the eligibility or procedural requirements explained in answers to Questions 1 through 4 of this section? If I have complied with the procedural requirements, on what other bases may a company rely to exclude my proposal? The company may exclude your proposal, but only after it has notified you of the problem, and you have failed adequately to correct it. Within 14 calendar days of receiving your proposal, the company must notify you in writing of any procedural or eligibility deficiencies, as well as of the time frame for your response. Your response must be postmarked, or transmitted electronically, no later than 14 days from the date you received the company's notification. * * * If the company intends to exclude the proposal, it will later have to make a submission under Rule 14a-8 and provide you with a copy *** Shareholder proposal rule Chapter 16 Public Shareholder Activism

What is a proposal? Who is eligible to submit a proposal, and how do I demonstrate to the company that I am eligible? How many proposals may I submit? How long can my proposal be? What is the deadline for submitting a proposal? What if I fail to follow one of the eligibility or procedural requirements explained in answers to Questions 1 through 4 of this section? If I have complied with the procedural requirements, on what other bases may a company rely to exclude my proposal? (1) Improper under state law: If the proposal is not a proper subject for action by shareholders under the laws of the jurisdiction of the company's organization; (5) Relevance: If the proposal relates to operations which account for less than 5% of the company's total assets at the end of its most recent fiscal year, and for less than 5% of its net earnings and gross sales for its most recent fiscal year, and is not otherwise significantly related to the company's business; (7) Management functions: If the proposal deals with a matter relating to the company's ordinary business operations; Shareholder proposal rule Chapter 16 Public Shareholder Activism

What’s excludable? Chapter 16 Public Shareholder Activism

Facts: Iroquois Brands annual revenue = $141 million Annual profits = $6 million Assets = $78 million Pate de foie gras Annual sales = $79,000 Annual profits = ($3,212) Assets = $34,000 Issue: How is pate “relevant” to company’s business? Holding: According to SEC (1976) “not hinge solely on economic relativity” / relevance “not limited to economic significance” Lovenheim v. Iroquois Brands(D DC 1985) Chapter 16 Public Shareholder Activism

Submitted to Iroquois Brands, Ltd. by Peter C. Lovenheim, Esq. 1545 18th St., NW Washington, DC 20036 December 5, 1983 WHEREAS, Iroquois Brands, Ltd. distributes in the United States the Edouard Artzner brand of pate de foie gras (goose liver pate), manufactured by the Edouard Artzner Co. of Strasbourg, France, and WHEREAS, the prevailing method of producing pate de foie gras in France involves the force-feeding of geese until their livers become enlarged, and WHEREAS, in the opinion of many individuals expert in animal care, this practice can cause undue pain and distress to the animals involved, and WHEREAS, Iroquois Brands, Ltd. strives to maintain a reputation as a distributor of wholesome foods, a reputation that enhances its ability to market successfully its entire line of health foods, vitamins, and other food products, therefore BE IT RESOLVED: that in order to assure that the Corporation is not inadvertently promoting cruelty to animals and does not risk damaging its reputation as a distributor of wholesome foods, the shareholders request that the Directors form a committee to study the methods by which its French supplier produces pate de foie gras, and report to the shareholders its findings, together with its opinion, based on expert consultation, as to whether or not this production method causes undue distress, pain, or suffering to the animals involved and, if [*4]so, whether future distribution of this product should be discontinued until a more humane production method is developed. SUPPORT STATEMENT Force-feeding is done to enlarge the liver and thus produce a large quantity of pate. As described in French agricultural journals, force-feeding begins when geese are four months old. On some farms where feeding is mechanized, the bird's body and wings are placed in a metal brace and its neck stretched. Through a funnel inserted 10-12 inches down its throat, a machine pumps up to 400 grams of corn-based mash into its stomach. An elastic band around the goose's throat prevents regurgitation. When feeding is manual, a handler uses a funnel and stick to force the mash down. Feeding is repeated two to four times a day for 28 days, until the animal's liver has been enlarged six times -- from 150 to about 900 grams. After slaughter, the liver is made into pate. This is not just raising animals for food; this is an aberrant and unethical practice. For this reason, the American Society for the Prevention of Cruelty to Animals, the nation's oldest and largest animal protection organization, supports this resolution. In 1983, management told you to vote against a similar resolution. Nevertheless, shareholders cast more than 50,000 votes in favor. This year has been a profitable one for our company. Yet profits made at the expense of animal suffering are tainted. They mar our reputation and prevent us from becoming as good and as proud a company as can be. This year, let's send an even stronger message to management to demonstrate our concern. January 23, 1984 RESPONSE OF THE OFFICE OF CHIEF COUNSEL DIVISION OF CORPORATION FINANCE Re: Iroquois Brands, Ltd. Incoming letter dated December 13, 1983 The proposal relates to the establishment of a committee to study the methods by which the Company's French supplier produces pate de foie gras. There appears to be some basis for your opinion that the proposal may be omitted from the Company's proxy material under Rule 14a-8 (c)(5). Under the circumstances, this Division will not recommend any enforcement action to the Commission if the Company omits the subject proposal from its proxy material. Sincerely, John J. Gorman Special Counsel Chapter 16 Public Shareholder Activism

Medical Committee (DC Cir 1972) Mgmt can’t treat corp. as “personal satrapies” Must include proposal on napalm sales SEC Interpretive Release (1976) Significant policy, economic implications Beyond ordinary business SEC no-action letters (1976-1991) Requests for EEO reports includable (1983) EEO policies includable (through 1991) Cracker Barrel (1992) SEC affirms staff: EEO “ordinary” Even though tied to social issue Reversal of Cracker Barrel (1998) Resubmission by NYCERS Majority/ISS support -- 58% shareholders Social/political proposals Chapter 16 Public Shareholder Activism

History and use of 14a-8 … Shareholder proposals submitted (2006-13) Source: ProxyMonitor.org Chapter 16 Public Shareholder Activism

History and use of 14a-8 … Process and SEC role … Source: ProxyMonitor.org Chapter 16 Public Shareholder Activism

Shareholder proposes Mgmt excludes SEC reviews Chapter 16 Public Shareholder Activism

“There’s not a bright line distinction between what used to be social policy issues and straight shareholder-value concerns” Nell Minow “The Corporate Library” Chapter 16 Public Shareholder Activism

Who proposes? GE - Shareowner Proposal No. 1 Evelyn Y. Davis, Watergate Office Building, 2600 Virginia Avenue, N.W., Suite 215, Washington, D.C. 20037, has notified us that she intends to present the following proposal at this year’s meeting: “RESOLVED: That the stockholders of General Electric, assembled in Annual Meeting in person and by proxy, hereby request the Board of Directors to take the necessary steps to provide for cumulative voting in the election of directors, which means each stockholder shall be entitled to as many votes as shall equal the number of shares he or she owns multiplied by the number of directors to be elected, and he or she may cast all of such votes for a single candidate, or any two or more of them as he or she may see fit. “REASONS: Many states have mandatory cumulative voting, so do National Banks. “In addition, many corporations have adopted cumulative voting. Chapter 16 Public Shareholder Activism

Have shareholder proposalsbeen successful? Chapter 16 Public Shareholder Activism

Who is supporting shareholder proposals? Chapter 16 Public Shareholder Activism

Case study: “Say on pay”Ragan Adamson & Daniel Lumm Chapter 16 Public Shareholder Activism

Proxy access 2005: Allows exclusion of proxy access bylaw -- “relates to election” New DGCL S 112 (2009) 2 Dodd-Frank Act (2010) 2010: Revises 14a-8 to permit proposals for proxy-access bylaws 2003: Proposes Proxy Access Rule 14a-11 1 5 4 3 2010: Adopts 14a-11 for short-slates nominated by 1/3/5% shareholder/groups 2007: Revises 14a-8 to exclude proposals that “relate to nominations” Business Roundtable v SEC (DC Cir 2011) AFSCME v AIG (2d Cir 2006) Chapter 16 Public Shareholder Activism

RESOLVED, pursuant to the AIG Bylaws and DGCL 109(a), stockholders amend the Bylaws: • "The Corporation shall include in its proxy materials … the name, together with the Disclosure and Statement, of any person nominated for election to the Board of Directors by a stockholder or group … Each Nominator may nominate one candidate for election at a meeting. • “To be eligible, a Nominator must: • (a) have beneficially owned 3% or more of the Corporation's outstanding common stock for at least one year; • (b) provide written notice [about the nominee]; and • (c) [undertake to assume any liability and comply with law].” Maurice "Hank" Greenberg Chapter 16 Public Shareholder Activism

Del GCL § 109. Bylaws. (a) … The power to adopt, amend or repeal bylaws shall be in the stockholders entitled to vote …; provided, however, any corporation may, in its certificate of incorporation, confer the power to adopt, amend or repeal bylaws upon the directors …. The fact that such power has been so conferred upon the directors or governing body, as the case may be, shall not divest the stockholders …, nor limit their power to adopt, amend or repeal bylaws. (b) The bylaws may contain any provision, not inconsistent with law or with the certificate of incorporation, relating to the business of the corporation, the conduct of its affairs, and its rights or powers or the rights or powers of its stockholders, directors, officers or employees. (8 Del. C. 1953, § 109; 56 Del. Laws, c. 50; 59 Del. Laws, c. 437, § 1.) Chapter 16 Public Shareholder Activism

Del GCL § 112. Access to proxy solicitation materials. The bylaws may provide that if the corporation solicits proxies with respect to an election of directors, it may be required …. to include in its proxy solicitation materials ... 1 or more individuals nominated by a stockholder. Such procedures or conditions may include any of the following: • A provision [relating to qualified nominating stockholder] • A provision requiring [disclosures about nominating stockholder and nominees] • A provision conditioning eligibility [based on number of directors or prior nominations] • A provision precluding nominations by [hostile bidders / acquirors] • A provision requiring [indemnification for false/misleading statements] 77 Del. Laws, c. 14, § 1 (2009) Chapter 16 Public Shareholder Activism

Piet Mondrian, “Broadway Boogie Woogie” (1943)