ProfessorBainbridge.com

Dear Securities and Exchange Commission: I Do Not Want to Know How my Funds Vote

From Davis Polk:

On September 29, 2021, the Securities and Exchange Commission (SEC) proposed amendments to Form N-PX to enhance the information mutual funds, exchange-traded funds (ETFs), and other registered management investment companies (collectively, funds) currently report annually about their proxy votes. The SEC also proposed new Rule 14Ad-1 under the Securities Exchange Act of 1934, as amended (Exchange Act) and amendments to Form N-PX to require institutional investment managers subject to Section 13(f) of the Exchange Act (managers) to report annually on Form N-PX how they voted proxies on executive compensation, or so-called “say-on-pay” matters.

...

The SEC is also proposing to require funds and managers to categorize each proxy voting matter reported on Form N-PX so that investors can focus on the topics they find important.

I am going to try to explain this in words simple enough even for an SEC bureaucrat to understand: Because I am an intelligent investor, I invest in passively managed index funds. The only thing I need or want to know about my funds is whether they are matching the index they claim to track. In the case of my S&P 500 fund, for example, all I want to know is how the S&P 500 index did in the relevant period and how the fund did. 

I do not want my funds spending my money on administrative nonsense like detailed proxy voting disclosures. All that does is raise my costs and reduce my returns.

How hard is that for you people to understand?

SEC Commissioner Hester Peirce was the sole commissioner to vote against this moronic proposal. She explained that:

Although a fund’s voting strategy can be an important part of the overall fund management strategy, how or why a fund votes, or even whether a fund votes on a particular issue at a particular portfolio company is unlikely materially to influence an investor’s choice to invest in a particular fund. 

Exactly right.

So what's going on here? Is the SEC just stupid? Or is this part of Chairman Gary gensler's woke capitalism agenda? Back to Commissioner Peirce:

The real interest in this kind of detailed voting information seems to come from activists and the ever-expanding population of “stakeholders,” for whom proxy voting seems to be the fund’s highest purpose.  In 2003, when the SEC was considering the original Form N-PX fund voting disclosure mandate, the heads of the two then-largest asset managers jointly penned a remarkably prescient Wall Street Journal opinion piece.  In it, they warned that:

[R]equiring mutual-fund managers to disclose their votes on corporate proxies would politicize proxy voting.  In case after case, it would open mutual-fund voting decisions to thinly veiled intimidation from activist groups whose agendas may have nothing to do with maximizing our clients’ returns.

Using Non-GAAP Accounting to Determine the Legality of a Dividend

From The CorporateCounsel.Net:

The question of the legality of a dividend or repurchase under Delaware law is one that often arises in leveraged recaps and other transactions involving large distributions to shareholders. The answer usually depends on whether the company has sufficient “surplus” within the meaning of Section 154 of the DGCL. The Delaware Supreme Court has held that what matters in the surplus calculation is the present value of the company’s assets & liabilities, not what’s reflected on the balance sheet. Since that’s the case, valuations are often used to determine the amount of available surplus.

While that’s a pretty common practice, there’s not a lot of Delaware case law on how the board’s valuation decisions will be assessed. That’s kind of disconcerting, particularly since directors face the prospect of personal liability for unlawful dividends or stock repurchases. Fortunately, the Chancery Court’s recent decision in In re The Chemours Company Derivative Litigation, (Del. Ch.; 11/21), provides some guidance to boards engaging in this process. Here’s an excerpt from this Faegre Drinker memo on the decision:

In this case, the board approved both dividends and stock repurchases at a time when the company also faced legacy contingent environmental liabilities that conceivably could render Chemours insolvent.

The court deferred to the board’s determination that there was sufficient surplus to permit these transactions, even though the board looked beyond GAAP-metrics to evaluate its contingent liabilities. The court held that it “will defer to the Board’s surplus calculation ‘so long as [the directors] evaluate assets and liabilities in good faith, on the basis of acceptable data, by methods that they reasonably believe reflect present values, and arrive at a determination of the surplus that is not so far off the mark as to constitute actual or constructive fraud.” This standard is consistent with the court’s prior guidance that the DGCL “does not require any particular method of calculating surplus, but simply prescribes factors,” total assets and total liabilities, “that any such calculation must include.”

As for reliance on experts, the court held that, under the DGCL, utilization of and good faith reliance on experts “fully protects” directors from personal liability arising from their surplus calculation. In reaching this conclusion, the court rejected the argument that the directors were required to second-guess the GAAP-based reserves calculated by the experts — an analysis that permitted the board to significantly reduce the size of these liabilities on Chemours’ balance sheet.

This should not be a surprising result. As I explain in my book Corporate Law:

Consider a relatively simple balance sheet:

	Assets			Liabilities and Shareholder equity
	Land	$  9,000		Total liabilities:	$38,000
	Other	$24,000		Capital:	$15,000
	Total	$33,000		Surplus	($20,000)
			Total shareholder equity		($  5,000)

This corporation could not pay a dividend under either the MBCA or Delaware approach. Under the MBCA, total liabilities already exceed total assets, so a distribution could not be made. Under Delaware law, the corporation has no surplus and, assuming it could not pay a nimble dividend, thus could not pay a dividend.

Notice, however, that the corporation owns real property being carried on the balance sheet at $9,000. Because assets generally are carried on the books at their historical cost, and land tends to appreciate in value, it is a fair supposition that the land may be worth much more than $9,000. Suppose the fair market value of the land in fact is $30,000. If we “write up” the value of the land to $30,000, the corporation will have total assets of $54,000, and now may pay a dividend. Under the MBCA, total assets exceed total liabilities by $16,000, which is available for distribution. Under Delaware law, net assets are now $16,000, which results in a surplus of $1,000, which is available for payment of a dividend.

Generally accepted accounting principles (GAAP) require that most assets be carried on the books at historical cost less depreciation. Accordingly, you may not write up assets to reflect an increase in their fair market value, but must write them down to reflect depreciation. In contrast, state corporate law generally does not require adherence to GAAP in determining whether a dividend lawfully may be paid. Indeed, MBCA § 6.40(d) expressly authorizes a corporation to use “a fair valuation or other method that is reasonable under the circumstances” in determining the amount of total assets and total liabilities. Accordingly, while the corporation may rely on financial statements prepared in accordance with GAAP, there is no requirement that it do so. The drafters’ comments on § 6.40, moreover, go on to state that the statute authorizes departures from historical cost accounting in determining the funds available for distribution. The comments further indicate that a corporation generally may not selectively revalue assets, however. If it is going to revalue some assets, all must be reappraised and adjusted to their fair market value. Delaware and New York reach the same result through case law.[1]

The principal wrinkle in the Chemours case is that, instead of suing directors for departing from GAAP, the plaintiffs here are suing the directors for "relying on GAAP-based accounting reserves to calculate surplus, which the Plaintiffs argue exclude contingent environmental liabilities."

States with Limited Liability Limited Partnership Statutes as of 2021

Expect the SEC to Favor Woke Shareholder Proposals: The SEC's Appalling New 14a-8 Guidance

Wachtell Lipton reports:

The SEC Staff has issued revised guidance rescinding prior Staff Legal Bulletins addressing the exclusion of Rule 14a-8 shareholder proposals based on the social significance to a company, “micromanagement” or  “economic relevance.”  The changes will likely facilitate a larger number of shareholder proposals, including ESG proposals, coming to a shareholder vote. ...

The new guidance revises the SEC’s application of the “ordinary business” exclusion, which considered whether a proposal was of social policy significance or sought to micromanage a company.  While the Staff has previously focused on the significance of a social policy issue to a particular issuer, they will now focus on the proposal’s “broad societal impact.”  

This is appalling. In effect, the SEC is saying that corporate proxy statements can be conscripted by somebody owning a trivial amount of stock to solve "societal problems" that may have virtually no nexus to the company.

In addition, the SEC is encouraging shareholders to micromanage the company when it comes to woke issues:

For example, a proposal requesting a company set greenhouse gas emission targets, but providing the company with discretion on a method for its implementation, will no longer meet the threshold for exclusion based on micromanagement.  

How is deciding corporate environmental policy not micromanagement?

Wachtell concludes:

it is not clear which social issues the Staff will deem broad enough to “transcend the ordinary business,” beyond the Staff’s examples of proposals relating to human capital management with a broad social impact or to greenhouse gas emissions targets without specific methodologies.  

Piffle. It is perfectly obvious that the SEC has become a tool of the Warren/Sanders/AOC wing of the Democratic Party and is now leading the charge towards woke capitalism. I feel confident in predicting that woke shareholder proposals will breeze through the process. In the unlikely event that conservatives emulated progressives and started using the shareholder proposals to effect their policy goals, however, I'd bet the SEC allows their exclusion.

 

Lipton on Pollman on the Supreme Court’s “Pro-Business Paradox”

Ann Lipton reports:

Elizabeth Pollman has a new Comment, published in the Harvard Law Review, on what she calls “The Supreme Court’s Pro-Business Paradox.”  She makes several very well-argued points.  First, that by weakening corporate regulation, the Supreme Court has put greater pressure on corporate governance to constrain antisocial corporate behavior; second, the Court’s rulings are arguably at odds with the preferences of corporate shareholders, whose interests the Court clams to be furthering; and third, that in its zeal to insulate corporations from liability, the Supreme Court has turned corporate governance concepts upside-down – by, for example, holding that the Alien Tort Statute makes corporations less responsible for the “decisionmaking” that occurs in boardrooms than for the actions of employee-agents lower down in the hierarchy.   

First, "decisionmaking" is not a word. "Decision making" is a word. As is the compound adjective, "decision-making." But I quibble.

Second, I agree that Elizabeth's article is well worth reading. But must respectfully dissent from of her arguments.

Is the Supreme Court "pro-business"? I refer you to Business and the Roberts Court, edited by friend Jonathan Adler, about which I wrote that:

"It is commonplace for politicians, journalists, and the public at large to debate whether the Supreme Court is 'pro-business.' As the essays in this outstanding volume demonstrate, however, this is not just the wrong question-it is an inherently incoherent question. One cannot analyze Supreme Court decisions by simply totting up wins and losses from a single term, as many mindless end-of-term articles try doing. Instead, one must take a longer view over many terms. But even if one does so it is rarely obvious that specific decisions can be easily categorized as pro- or anti-business."

Why should we care about the preferences of corporate shareholders? As famed Delaware Chancellor William Allen observed:

Our “corporation law does not operate on the theory that directors, in exercising their powers to manage the firm, are obligated to follow the wishes of a majority of shares. In fact, directors, not shareholders, are charged with the duty to manage the firm.” Paramount Communications Inc. v. Time Inc., 1989 WL 79880 at *30 (Del. Ch. 1989), aff’d, 571 A.2d 1140 (Del. 1990).

 

Keith Paul Bishop asks: "Should Boeing Fly To Nevada?"

Mr. Bishop cites my post After Boeing, Caremark is no longer "the most difficult theory in corporation law upon which a plaintiff might hope to win a judgment" and then points out that:

If Professor Bainbridge is correct, Caremark is no longer a tough claim to bring, Caremark claims will increase, and more stockholder money will be spent in defending and settling Caremark claims.

Boeing and its stockholders may want to take note of the fact that the Nevada Supreme Court has never mentioned, much less followed, Caremark.   Further, NRS 78.138 provides that, with certain exceptions, no director or officer is individually liable to the corporation or its stockholders for damages unless the business judgment presumption has been rebutted and it is proven that:

• The director’s or officer’s act or failure to act constituted a breach of his or her fiduciary duties as a director or officer; and

• Such breach involved intentional misconduct, fraud or a knowing violation of law.

I am the Ninth Most Cited Corporate Law Academic of All-Time

Fred Shapiro (Yale Law School) periodically published citation counts. He has just published a new one in The Most-Cited Legal Scholars Revisited, 88 U. Chi. L. Rev. 1595 (2021). As far as corporate law goes, he has me ranked ninth:

Unlike the Leiter-Sisk rankings, which look at citation counts over a recent span of years, Shapiro's count looks at all-time counts.

"Where will the elderly poor, disabled, or dying in our world fit into Mr. Zuckerberg’s metaverse?"

In other words, Mr. Zuckerberg wants us to become some kind of gods. That rings a bell. Wasn’t that vision the one the serpent in the Garden of Eden used to deceive Adam and Eve into eating forbidden fruit? ... Facebook knows human beings and their weaknesses well. Its team is again poised to prey on the youth, for whom the metaverse is designed, and pilfer large chunks of their lives while shaking down advertisers for access to their minds. ...

Where will the elderly poor, disabled, or dying in our world fit into Mr. Zuckerberg’s metaverse? They won’t. Their real-world isolation and suffering, and the groans and dreams of the developing world, will find no place in a make-believe playhouse ruled by a pioneering Meta-billionaire and his programmers and technocrats.

God’s Universe Beats Mark Zuckerberg’s Metaverse by Jim Towey https://t.co/4lrGykh5hW

— Steve Bainbridge (@PrawfBainbridge) November 5, 2021

By normalizing Caremark claims, the Delaware courts are encouraging litigation by jacking the settlement value of such claims into the heights

Regular readers will recall that my latest law review article is Don’t Compound the Caremark Mistake by Extending it to ESG Oversight (September 2021), which is available at SSRN: https://ssrn.com/abstract=3899528. They will also recall my PB.com post After Boeing, Caremark is no longer "the most difficult theory in corporation law upon which a plaintiff might hope to win a judgment", in which I argued that:

“It has become among the hoariest of Chancery clichés for an opinion to note that a derivative claim against a company’s directors, on the grounds that they have failed to comply with oversight duties under Caremark, is among the most difficult of claims in this Court to plead successfully.” Teamsters Local 443 Health Servs. & Ins. Plan v. Chou, 2020 WL 5028065, at *1 (Del. Ch. Aug. 24, 2020).

As I explained in my post, Is Caremark still the hardest claim for plaintiffs to win in corporate law?, there has been a steady erosion of that principle in the Delaware courts. Indeed, it is getting easier and easier for a plaintiff to at the very least get past the motion to dismiss stage of the litigation (at which point the pressure on defendants to settle becomes almost unbearable).

Yesterday's opinion in In re The Boeing Company Derivative Litigation by  Delaware Vice Chancellor Zurn is the latest nail in that cliche's coffin. 

In today's WSJ, it was reported that:

Current and former Boeing Co. directors have reached an approximately $225 million agreement to settle a shareholder lawsuit that claimed the plane maker’s board failed to properly oversee safety matters related to the 737 MAX, according to people familiar with the matter.

As part of the proposed settlement, Boeing has agreed to hire an ombudsman to handle internal issues and appoint a board member with experience in aviation safety, some of these people said.

The article does not indicate how big of a chunk of that settlement will go to the plaintiff class' lawyers.

The erosion of Caremark coupled with a huge payout for the lawyers will make it more likely that suits like this will be filed, less likely that directors will be able to get Caremark claims dismissed at the motion to dismiss stage, and thereby drive up the settlement value of such claims. It'll be a vicious circle.

What's Martin Lipton of Wachtell Lipton up to with ESG?

Proposition: Wachtell Lipton spent the 1980s insulated boards of directors from hostile takeover bids. Today, Wachtell Lipton is pushing #ESG to insulate boards from hedge fund activists like Dan Loeb's run at Shell. See: https://t.co/nRWCFI5fow

— Steve Bainbridge (@PrawfBainbridge) November 1, 2021

Would a board failure to have cybersecurity oversight programs in place violate Caremark?

Gibson Dunn partner Eduardo Gallardo has a most interesting post at the CLS Blue Sky Blog on the titular question. He concludes:

In light of the emphasis that the SEC and other regulators have placed on cybersecurity issues, the increasing amount of  litigation over  cybercrime, and the guidelines offered by Caremark and its progeny, boards should assess whether cybersecurity is “mission critical” to their business and, if so, should proactively incorporate cybersecurity issues into their oversight functions.

I think that, given the direction of case law in Delaware, he's probably right; so go read the whole thing.

On the other hand, as a policy matter, I deplore the direction of Delaware law in this area. A revised version of my paper Don’t Compound the Caremark Mistake by Extending it to ESG Oversight is now up at SSRN. The abstract follows:

Since the foundational decision in In re Caremark Intern. Inc. Derivative Litig., 698 A.2d 959 (Del. Ch. 1996), Delaware corporate law has required boards of directors to establish reasonable legal compliance programs. Although Caremark has been applied almost exclusively with respect to law and accounting compliance, the original Caremark decision contemplated applying the oversight duty to the corporation’s “business performance.” Accordingly, there is no doctrinal reason that Caremark claims should not lie in cases in which the corporation suffered losses, not due to a failure to comply with applicable laws, but rather due to lax risk management.

The question thus arises as to whether Caremark should be extended to board failures to exercise oversight with respect to environmental, social, and governance (ESG) factors. Obviously, where existing legislation or regulations impose compliance obligations in ESG-related areas, such as human resources, the environment, or worker safety, Caremark already applies. As such, boards must “ensure that compliance and monitoring systems are in place” to oversee corporate compliance with those laws.

Many ESG issues are not yet the subject to legal requirements, however. The question addressed in this Article is whether the board’s Caremark obligations should be extended to encompass oversight of corporate performance with such issues. In other words, should the board face potential liability not just for failing to ensure that the company has adequate reporting and monitoring systems in place to insure compliance with ESG-related legal requirements, but also to monitor ESG risks in areas where corporate compliance would be voluntary or aspirational.

Padfield and Heminway discuss viewpoint diversity shareholder proposals

Joan Heminway has a blog post discussing a paper by Stefan Padfield and for response thereto with regard to viewpoint diversity shareholder proposals. Good stuff all around.