This morning, a divided panel of the U.S. Court of Appeals for the D.C. Circuit again concluded that the Securities and Exchange Commission’s “conflict minerals” disclosure requirement violates the First Amendment. The court had initially struck down the disclosure rule in April of last year, but agreed to reconsider the decision in light of the D.C. Circuit’s en banc decision upholding the U.S. Department of Agriculture’s meat country-of-origin labeling requirements in American Meat Institute v. USDA.
We use a unique setting to study the tradeoffs between universal regulatory mandates and private contracting in the field of corporate governance. Events surrounding the legal challenge of a 2010 proxy access rule allow us to benchmark the market’s expectation of the benefits of universally mandated proxy access even though this rule never came into effect. At the same time, a 2010 rule amendment facilitating shareholder proposals for proxy access opened a new channel for proxy access through "private ordering." We document that this private channel has been active, spawning about 160 proxy access proposals, and use the unexpected announcement of a major private ordering initiative to identify a 0.5 percent increase in shareholder value for the targeted firms. However, our findings also underscore that private ordering may lead to a second best outcome. We find that proponents do not selectively target those firms that were expected to benefit the most from universally mandated proxy access, and that tailoring of proposal terms is limited. Moreover, management is more likely to challenge proposals at firms that stand to benefit more. Overall, we find that private ordering creates value, but it may not efficiently deliver proxy access at the firms that need it most.
Bhandari, Tara and Iliev, Peter and Kalodimos, Jonathan, Public Versus Private Provision of Governance: The Case of Proxy Access (July 24, 2015). Available at SSRN: http://ssrn.com/abstract=2635695
But what the paper does NOT prove is that SEC mandated proxy access would be superior. The SEC's effort to mandate proxy access entailed a one size fits all approach with no opportunity for tailoring to specific firm needs (except that shareholders could vote for enhanced access) and no opt out option for firms that simply don't need proxy access for effective corporate governance.
A “wolf pack” is a loose association of hedge funds (and possibly some other activists) that stop just short of forming a “group” (which would require disclosure under Section 13(d)(3) of the Williams Act once the “group” collectively held 5% or more of any class of the stock of the engaged firm). The essence of the “wolf pack” is conscious parallelism without any agreement to act in concert. The market can quickly recognize a “wolf pack” once its leader crosses the 5% threshold and files its Schedule 13D, and the market responds more enthusiastically to a “wolf pack” than to other activist investors, running up on average 14% in abnormal returns on the date of its public appearance. Also, the “wolf pack” acquires substantially more—at least 13.4% in on recent study. But this may understate, as researchers cannot know how many allies the wolf pack leader has. In the Sotheby’s proxy litigation last year, the CEO of a prominent proxy solicitor, testifying as an expert witness, estimated that hedge funds then held over 32% of Sotheby’s (a mid-cap sized firm).This is a near control block.
The key advantage of joining a “wolf pack” is that it offers near riskless profit. The hedge fund leading the pack can tip its allies of its intent to initiate an activist campaign because it is breaching no fiduciary duty in doing so (and is rather helping its own cause); thus, insider trading rules do not prohibit tipping material information in this context. If one can legally exploit material, non-public information, riskless profits are obtainable, and riskless profits will draw a crowd on Wall Street.
 For a fuller review of these tactics and the legal and market developments that made the “wolf pack” possible, as well as the concept of “group,” see John C. Coffee, Jr. and Darius Palia, “The Impact of Hedge Fund Activism: Evidence and Implications” (available at http://ssrn.com/abstract=2496518)(Oct. 2014).
 See Becht, Franks, Grant and Wagner, supra note 1, at 32. [Full cite: Marco Becht, Julian Franks, Jeremy Grant and Hammes F. Wagner, The Returns to Hedge Fund Activism: An International Study, (available at http://ssrn.com/abstract=2376271)(March 25, 2015).]
 Daniel Burch, CEO of Mackenzie Partners, so testified in the Sotheby’s litigation that hedge funds then held an estimated 32.68% of Sotheby’s. On the basis of the “threat” this constituted, the Chancery Court upheld a special “discriminatory” version of the poison pill. Third Point, LLC, the lead activist, held only 9.62% of Sotheby’s, thus showing the size of the allies that the “wolf pack” leader can assemble. See Third Point, LLC. v. Ruprecht, 2014 Del. Ch. LEXIS 64 (May 2, 2014).
It seems to me that there are several ways of responding to the wolf pack phenomenon.
First, amend Exchange Section 13(d) and the rules thereunder so that conscious parallelism requires filing a Schedule 13D. There is evidence that "wolf pack activity appears to be ostensibly uncoordinated—i.e., no formal coalition is formed—a fact that is usually attributed to an attempt by the funds to circumvent the requirement for group filing under Regulation 13D when governance activities are coalitional." Instead of requiring the SEC and/or the target to undertake the difficult task of proving that ostensibly uncoordinated activity is in fact coordinated, we should amend Section 13(d) to force wolf packs to disclose. After all, isn't sunlight the best disinfectant? In addition, as Wachtell Lipton has been urging for a long time, the 10 day window for filing Schedule 13Ds should be shortened to 2 business days.
Second, courts should be more receptive to arguments that wolf packs constitute a group that "may be liable under Section 16(b) if, in the aggregate, the group’s holdings exceed ten percent of the company’s nonexempt, registered equity securities."
... a traditional poison pill follows the federal securities laws in determining when shareholders are considered a “group” and would generally aggregate their ownership if, and only if, they entered into an agreement to act in concert with respect to their stock in the company. There is no definitive legal authority on whether a poison pill would be legally valid if it aggregated stock ownership of investors who patterned their behavior after one another, but did not have an agreement to act in concert. To avoid potential litigation, companies generally utilize the 13D definition of “group” in their shareholder rights plans although this means that their poison pill may not be an effective weapon against a wolf pack.
The Sotheby’s case may cause practitioners to rethink the desirability of adopting a wolf pack pill. Sotheby’s found that the acquisition of stock by members of a wolf pack could be a threat to the corporation based on a pattern of behavior the court described as “conscious parallelism.” The same analysis may also justify a wolf pack clause in a poison pill.
So, why have the reforms been so ineffective? Indeed, they have targeted the wrong things. Say-on-Pay was based on the mistaken belief that the root cause of high CEO pay was poor oversight by boards and investors. What we are seeing can easily be concluded as proof that boards are not lazy, stupid, or corrupt, and that investors–a very large and diverse crowd–are getting pretty much what they pay for, and they know it.
On April 14, 2015, the U.S. Court of Appeals for the Third Circuit overturned a lower court decision that would have required publicly traded companies to include frivolous and inappropriate shareholder proposals in proxy statements at the company’s expense—and, therefore, at the expense of every other shareholder. In a concise, two-page order, the appeals court vacated the district court’s order, concluding that “Wal-Mart may exclude Trinity’s Proposal from its 2015 proxy materials.” The decision was a victory for WLF, which filed a brief in the case arguing that the proposal was not only excludable under the SEC’s “ordinary business” exception, because it related to Wal-Mart’s ordinary business matters, but the proposal was so vague that neither the company nor its shareholders would be able to determine with any reasonable certainty what actions the proposal would require. The appeals court will issue a more detailed opinion explaining its decision in the coming weeks.
The Washington Legal Foundation has filed an amicus brief in Trinity Wall Street v. Wal-Mart Stores, Inc. As their press release explains:
The U.S. Court of Appeals for the Third Circuit will hear oral argument in Philadelphia tomorrow, April 8, in a closely watched case that will determine when individual corporate shareholders can force a corporation to include shareholder proposals in its annual proxy statement. ...
In this case, an activist shareholder sought to include a proposal in Wal-Mart’s proxy materials that would, if adopted, compel the board’s governance committee to review the company’s policies concerning the sale of potentially dangerous or offensive products. WLF argues that the “ordinary business” exception permits exclusion of proposals about the nature of the products the company sells.
The WLF's position has to be correct. If the court goes the other way, the ordinary business exception will have been completely eviscerated. Shareholders will be empowered to micro-manage basic business decisions.
Ann Lipton offers an interesting analysis of the pleading implications of the Supreme Court's recent Omnicare decision, which dealt with whether and when opinions can give rise to 1933 Act Section 11 claims.
John Coffee highlights an important wrinkle in the legislation proposed by the Delaware state bar to ban fee shifting bylaws and charter provisions:
Fee-shifting bylaws and charter provisions are only precluded “in connection with an intracorporate claim.” What is that? Proposed new Section 115 of the DGCL would define “intracorporate claim” to mean “claims, including claims in the right of the corporation, (I) that are based upon a violation of a duty by a current or former director or officer or stockholder in such capacity, or (II) as to which this title confers jurisdiction upon the Court of Chancery.” ...
Coffee goes on to point out, I think correctly, that the legislative language appears to have been carefully crafted to permit fee shifting bylaws that apply to federal securities regulation:
Before we assume that the narrow phrasing of Sections 102 and 109 was an oversight by the Corporation Law Council, we need to consider the alternative possibility: namely, that they deliberately wrote it narrowly. Why? This is speculative and may sound cynical, but the Corporation Law Council may have wanted to cover only traditional “Delaware-style” litigation (where the interests of the Delaware Bar on both sides were jeopardized if “loser-pays” fee-shifting were to reduce the volume of such litigation). In contrast, securities litigation tends not to be brought in Delaware nor to involve Delaware counsel in most cases. If the goal was to protect the local Bar, nothing more needed to be done than to exempt “Delaware-style” litigation from the impact of “loser pays” fee shifting.
Because I believe that the bill is intended to protect the interests of the Delaware bar, I find that a very plausible hypothesis.
Coffee goes on to offer a detailed preemption analysis, which concludes--albeit somewhat tentatively--that state laws authorizing (even implicitly) fee shifting bylaws that apply to federal securities regulation would be invalid.
Apropos of which, William Sjostrom has a new article out that deals with the preemption issue:
The Article examines the intersection of fee-shifting bylaws and federal private securities fraud suits. Specifically, the Article hypothesizes about the effects fee-shifting bylaws would have, if enforceable, on private securities fraud litigation. It then turns to the validity of fee-shifting bylaws under federal law and concludes that they are invalid as applied to securities fraud claims. In light of this conclusion, the Article considers whether Congress should pass legislation to validate fee-shifting bylaws and determines that it should not.
Note: The Appendix at the end of the Article includes some data on corporations that have adopted fee-shifting bylaws or charter provisions between May 8, 2014 and March 16, 2015.
The Intersection of Fee-Shifting Bylaws and Securities Fraud Litigation (March 19, 2015). Washington University Law Review, Forthcoming. Available at SSRN: http://ssrn.com/abstract=2580943
What is it about Omnicare, Inc., that generates such awful judicial opinions? The Delaware supreme court's decision in Omnicare v. NCS Healthcare, 818 A.2d 914 (Del. 2003), was one of that Court's worst decisions.
Before a company may sell securities in interstate commerce, it must file a registration statement with the Securities and Exchange Commission (SEC).
Granted, she recovered almost immediately by observing in the next paragraph that:
With limited exceptions not relevant here, an issuer may offer securities to the public only after filing a registration statement.
But, as a FB friend of mine observed, why didn't somebody correct the over broad opening sentence?
As for the merits of the decision, Richard Booth aptly observes that "The bottom line is that Omnicare resolves an issue that most thought settled already, while ignoring the standard(s) of care that remain applicable under the 1933 Act." Alison Frankel similarly noted that:
This is getting to be an annual rite. The U.S. Supreme Court agrees to take a case that could significantly reshape the securities class action business. Defendants get their hopes up, loading the docket with amicus briefs calling on the justices to impose new restrictions on the cases. But ultimately the justices leave the status quo more or less intact, to the relief of shareholder lawyers across the land.
Kevin LaCroix has a typically detailed and cogent analysis of the relevant legal issues on his blog. He also reprints a helpful Skadden client memo on the case.
My friend and UCLAW colleague James Park has posted his article Bondholders and Securities Class Actions (January 15, 2015), available at SSRN: http://ssrn.com/abstract=2550398. Here's the abstract:
Prior studies of corporate and securities law litigation have focused almost entirely on cases filed by shareholder plaintiffs. Bondholders are thought to play little role in holding corporations accountable for poor governance leading to fraud. This Article challenges this conventional view in light of new evidence that bond investors are increasingly recovering losses through securities class actions. From 1996 through 2000, about 3% of securities class action settlements involved a bondholder recovery. From 2001 through 2005, the percentage of bondholder recoveries increased to about 8% of all securities class action settlements. Bondholders were involved in 4 of the 5 and 19 of the 30 largest securities class action settlements, and tended to recover in frauds associated with a credit downgrade. By 2005, almost half of all securities class actions alleged claims on behalf of all public investors, not just shareholders. The rise in bondholder recoveries is evidence that securities fraud has increased in severity over time, causing harm to a broader range of corporate stakeholders. Certain frauds can be understood as transferring wealth from bondholders to shareholders. In providing a remedy for such transfers, bondholder class actions are an example of the continuing evolution of the securities class action.
James has also posted a very detailed executive summary of the article on the Harvard corporate governance blog. Highly recommended.