ProfessorBainbridge.com

An open letter to Heritage President Kevin Roberts: I used to be proud of my Heritage Foundation affiliation, but ....

Will the SEC now allow shareholder proposals on abstract political, social, and economic questions?

The SEC's latest guidance on Rule 14a-8 (the shareholder proposal rule) abandoned an important limitation on the scope of permissible shareholder proposals:

Rule 14a-8(i)(7), the ordinary business exception, is one of the substantive bases for exclusion of a shareholder proposal in Rule 14a-8. It permits a company to exclude a proposal that “deals with a matter relating to the company’s ordinary business operations.” ...

... staff will no longer focus on determining the nexus between a policy issue and the company, but will instead focus on the social policy significance of the issue that is the subject of the shareholder proposal. In making this determination, the staff will consider whether the proposal raises issues with a broad societal impact, such that they transcend the ordinary business of the company.

It has been speculated that this announcement "represents a wholesale abandonment of any assessment of relevance of a proposal to a company’s business (as compared to relevance to society at large)." If so, it would represent an abandonment of longstanding rules, including "the “nexus” concept was embedded in the 1998 Release, as stated in Staff Legal Bulletin 14E (Oct. 27, 2009), at footnote 4 (citing the 1998 Release), and reaffirmed in Staff Legal Bulletin 14H (Oct. 22, 2015)."

I am reminded in this regard of a 1945 SEC opinion, which concluded that "the phrase “proper subject for action” to mean proposals which relate directly to the affairs of the particular corporation and concludes that proposals which deal with general political, social or economic matters are not, within the meaning of the rule, 'proper subjects for action by security holders.'" The Sec Today Released an Op. of Baldwin B. Bane, Release No. 735 (S.E.C. Release No. Jan. 3, 1945). Has the SEC now abandoned that position, such that "proposals which deal with general political, social or economic matters" unrelated tp the company's business will now be includable?

This makes no sense. As the 1945 release explained, the purpose of the shareholder proposal rule is "to place stockholders in a position to bring before their fellow stockholders matters of concern to them as stockholders in such corporation ...." The clear implication is that there must be some nexus between the proposal and the company's bison's activities:

... in 1945 the Commission issued a release containing an opinion of the Director of the Division of Corporation Finance that was rendered in response to a management request to omit shareholder resolutions which bore little or no relationship to the company's affairs; for example, these shareholder resolutions included proposals "that the anti-trust laws and the enforcement thereof be revised," and "that all Federal legislation hereafter enacted providing for workers and farmers to be represented should be made to apply equally to investors." The Commission's release endorsed the Director's conclusion that "proposals which deal with general political, social or economic matters are not, within the meaning of the rule, ‘proper subjects for action by security holders.'"

Med. Comm. for Human Rights v. Securities and Exch. Commn., 432 F.2d 659, 677 (D.C. Cir. 1970), vacated, 404 U.S. 403 (1972). Are shareholder proposals "that the anti-trust laws and the enforcement thereof be revised" now admissible? It seems possible:

“By repealing longstanding guidance about treatment of shareholders proposals, the SEC has stated its preference to turn board rooms and shareholder meetings into political debate societies on issues the SEC admits have no nexus to the actual business of the company,” Tom Quaadman, an executive vice president with the Chamber, said in a statement. “This will all come at the expense of companies' ability to focus on long-term performance, including the welfare of their employees, customers, and shareholders.”

Commissioners Criticize New SEC Staff Interpretation on Rules Governing Shareholder Proposals, WGL-ACCTALERT VOL 15 NO 213.

All of which strikes me as problematic. After all, shareholders have a “First Amendment interest in not being forced to be associated with political speech that they do not support." Lucian A. Bebchuk & Robert J. Jackson, Jr., Corporate Political Speech: Who Decides?, 124 Harv. L. Rev. 83, 113 (2010). If that's true about political speech by the corporate, as Bebchuk and Jackson claim, should it not be even more true with respect to political speech foisted upon the corporation by government fiat regardless of whether the speech has any meaningful relationship to the company's business?

Milbank ducks the hard question: Why does the SEC get to decide what issues have social significance?

In an otherwise very useful post on the new SEC shareholder proposal rule guidance, Milbank ducks the really hard question:

As a result of the SEC’s most recent Staff Legal Bulletin[1] (“SLB”), shareholder proposals that focus on a “significant social policy” will not be excludable simply because the policy issue is not, in fact, “significant” to the company receiving the proposal. The SEC has decided it will no longer “focus on the nexus between a policy issue and the company.”  Previously, shareholder proposals that did not raise a “policy issue of significance for the company” were excludable under the “ordinary course of business” exception to Rule 14a-8.[2] The new Staff Legal Bulletin is a departure from past SEC practice, and led the SEC to simultaneously rescind three previous Staff Legal Bulletins on the same subject.

Leaving aside the issue of why the SEC – which is presumably dedicated to the regulation of securities – should be determining in the abstract which social issue are “significant,” it is clear from the new bulletin that climate change and human capital management are issues that will be considered “significant.” Beyond that specific guidance, the SEC promises only that “in making this determination [regarding significance], the staff will consider whether the proposal raises issues with a broad societal impact.” This is a standard that doesn’t exactly hem in the SEC or limit the imagination of activists and gadflies.

Given the new woke majority at the SEC led by wide awake Gary Gensler, we can expect firms to be forced into including all sorts of progressive proposals having no meaningful nexus to their business. In a world in which the First and Seventh Amendments had teeth, this would be a regulatory taking by compelled speech.

Outside Reverse Veil Piercing in California

Keith Bishop reports:

Reverse veil piercing involves subjecting an entity to the liabilities of its owner.  See Inside and Outside Veil Piercing.   As Professor Bainbridge has noted, there are two types of reverse veil piercing:

One type might be called insider reverse veil piercing, in which a shareholder seeks to disregard the corporate entity.

The other is so-called outsider reverse piercing, in which a personal creditor of the shareholder seeks to disregard the corporation’s separate legal existence to reach assets of the corporation to satisfy its claim.

In a decision issued yesterday, the California Court of Appeal considered the second type of reverse veil piercing - outside reverse veil piercing.  Blizzard Energy, Inc. v. Bernd Schaefers,  2021 Cal. App LEXIS 968.  The plaintiff had obtained a judgment for nearly $4 million against an individual in Kansas.  When the plaintiff had the Kansas judgment entered in California, it asked the court to add two limited liability companies to the judgment based on the reverse alter ego doctrine.   The defendant's spouse, who had filed for a divorce, has a 50% interest in these LLCs.  She was not a defendant in the Kansas action.  The court added the LLCs as judgment debtors and the defendant appealed.

To learn how the case came out, go here.

A personal book plug

Now available—"Business Associations: Cases and Materials on Agency, Partnerships, LLCs, and Corporations, 11th" by @UCLA_Law Prof. @PrawfBainbridge. Learn more at https://t.co/0elwnAywzU (https://t.co/k5jHRGpkFF). #WestAcademicAuthor pic.twitter.com/MMn9RL7uXl

— West Academic for Faculty (@WestAcademic) November 17, 2021

A couple of book recommendations

My friend Marc Steinberg's wonderful book "Rethinking Securities Law" was American Book Fest's best law book of 2021. Well deserved award.https://t.co/JOiZklAFP2 https://t.co/uIVAyUbGVp #lawtwitter

— Steve Bainbridge (@PrawfBainbridge) November 17, 2021

"Ends of War: The Unfinished Fight of Lee's Army after Appomattox" got a strong review in today's WSJ. https://t.co/fUAQO77Lgr The Country likely would be in a better place if we had hung some top Confederates and kept Reconstruction going a lot longer. https://t.co/ZSZ9eGnZ20

— Steve Bainbridge (@PrawfBainbridge) November 17, 2021

An Oldie but a Goldie

In light of the spike in gold prices, I offer my old post: "Civilized People Don't Buy Gold"https://t.co/rX468BMCcG

— Steve Bainbridge (@PrawfBainbridge) November 17, 2021

Hearing on California's Board of Director Gender Quota Statute

Report from Cydney Posner of Cooley on the federal district court hearing on plaintiff's request for a preliminary injunction against enforcement of SB 826, which "requires that public companies (defined as corporations listed on major U.S. stock exchanges) that have principal executive offices located in California, no matter where they are incorporated, include specified minimum numbers of women on their boards of directors." 

It sound like the plaintiff's going to lose on that request and probably on the merits, as the judge reportedly stated that:

I think that the plaintiff hasn’t demonstrated enough of a likelihood of success on the merits on his claim that this law is unconstitutional to warrant a preliminary injunction, to stop the law now. It goes to my question obviously loaded and somewhat biased about the balance of equities in the public interest of stopping this law now, particularly when it appears to be working so well and is accomplishing the primary goal of remedying discrimination.

“So in terms of a likelihood of success on the merits, I am leaning towards finding that the defendants are more likely to succeed on the merits, and that the law should be upheld.

As regular readers know, I believe SB 826 is unconstitutional under the penumbra created by the full faith and credit and dormant commerce clauses, which constitutionalize the internal affairs doctrine. That issue is not being litigated in this case, however.

It turns out California is another state that doesn't require use of GAAP in deciding if a dividend is lawful

Keith Bishop:

UCLA Law School Professor Stephen Bainbridge recently commented Vice Chancellor Glasscock's recent memorandum opinion in In re The Chemours Co. Deriv. Litig., (Del. Ch. Case No. 2020-0786-SG, Nov. 1, 2021).  Professor Bainbridge notes that the Chemours case provides some guidance on how to boards of directors should make valuation decisions in determining whether a dividend may be paid under Delaware law.  He notes that state corporate laws generally does not require adherence to Generally Accepted Accounting Principles (GAAP) when determining whether a dividend can be paid.  I can't speak to other states' laws, but Professor Bainbridge is correct with respect to California.

Keith goes on to discuss the pertinent California statute in depth. Good read.

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