The latest victim of Lucian Bebchuk's shareholder activism crusade is video game maker Electronic Arts (maker of the iconic Madden 09 NFL game, which rocks BTW, and a host of other products for PCs, Xboxes, Playstations, and the like). Bebchuk is using Rule 14a-8 in an attempt to put the following proposal on EA's proxy statement for the upcoming shareholder meeting:
Jeff Gordon has a post linking all the briefs and discussing the key issues. Gordon Smith and Larry Ribstein have also posted on the case, as I have (see below).
The case has attracted a lot of attention, including several amicus briefs. Among the amici curiae is a group of 46 corporate and securities law professors, most hailing from elite schools. (Oddly enough, I was not asked to sign, despite being one of the 100 most influential people in corporate governance. :coolsmirk: ) Their brief focuses not on the substantive issues raised by the proposal, but on the initial question of whether EA is legally obliged to include the proposal on its proxy statement.
I recognize that those who signed the brief are not necessarily endorsing Bebchuk's proposal. At the very least, however, they are enabling Bebchuk's activist campaign.
Many of the 46 are friends of mine, for whom I have both affection and respect, so I criticize them with some trepidation, but they're advancing a pernicious cause.
Let us assume the following:
The Ave Maria funds put forward a proposal to amend the bylaws in a way that would require EA to stop making games rated for mature audiences.
In the absence of Bebchuk's proposal, it's uncertain whether the proposal could be excluded from the proxy statement if management objected. The company will argue (1) that the proposal can be excluded under 14a-8(i)1), because it is not a proper subject for shareholder action. There is a well known conflict in the Delaware code between the sections governing bylaws (109) and the powers of the board (141). The recent CA case suggests that, at least in some cases, the director primacy norms embedded in section 141 trump shareholder rights to adopt bylaws. Likely, this would be the case with respect to a bylaw that tried to preclude the corporation from engaging in a certain line of business.
The company will also argue that (2) the proposal can be excluded under the economic significance test in Rule 14a-8(i)(5) and the ordinary business exception in Rule 14a-8(i)(7). The trouble with this argument will be that the SEC has allowed proposals, such as restrictions on advertising by tobacco companies, when they raise social and ethical concerns.
Assume the SEC sided with the company. Many proponents would give up at this point, because they know that going to court will be an expensive proposition and the SEC's support for the company will weigh heavily in the court's analysis. Those who do go to court are likely to lose in short order for precisely that reason. Hence, having the SEC as a referee for the process offers an important gate-keeping function.
Now suppose Bebchuk's amendment passes. The Ave Maria funds make their proposal. The company argues that the fund's proposal is not "a proper action for stockholders under state law," as required by Bebchuk's amendment, because the director primacy rules inherent in section 141 trump the bylaw rights under section 109. The company further argues that the proposal relates "to the Corporation?s ordinary business operations." Finally, the board of directors, in the exercise of its fiduciary duties, decides that the proposal is such a bad idea it should not be put to a vote. (BTW, does the proposal as written contain an adequate fiduciary out? The relevant language would seem to be "to the extent permitted by law" rather than "to the extent consistent with its fiduciary duties," because the latter appears to modify only the initial issue of whether the amendment to the articles should go forward. A question for another day.)
The proponents argue that the terms "proper subject" and "ordinary business" can be interpreted in light of Rule 14a-8 precedents, since the Rule has very similar exclusions. They rely on cases like Lovenheim and Dole, to argue that proposals with ethical and social significance are a "proper subject" and rise above "ordinary business."
Who referees the dispute? Does Bebchuk's proposal allow shareholders to bypass Rule 14a-8 and thereby oust the SEC as referee? As I understand it, the answer is yes.
So if the company excludes the proposal, the proponent(s) will sue. What standard of review applies? Business judgment rule or, because it affects the franchise, Blasius? How much will the litigation cost the company? How long will the litigation take? Under the law in Delaware, shareholders can ask the Chancery Court to order a company to hold an annual shareholders meeting if more than 13 months have passed since the last one. But what if the litigation is preventing the company from completing a definitive proxy statement to solicit shareholders?
How much money, time, and effort will be soaked up to deal with a special interest proposal with almost no chance of passing?
Before you tell me this is a bogus problem, reflect on the long history of social activists using shareholder proposals to advance their pet causes even though the proposals routinely went down to defeat. Bebchuk's proposal will simply encourage this sort of thing.
Alternatively, what if the shareholder/proponent is using a proposal to pursue some sort of private rent-seeking. In my article, Director Primacy and Shareholder Disempowerment and my book The New Corporate Governance in Theory and Practice, I explored that issue, arguing that union and state and local pension funds are both the most active institutions with respect to corporate governance issues and also the institutions most likely to use their position to self-deal?i.e., to take a non-pro rata share of the firms assets and earnings?or to otherwise reap private benefits not shared with other investors. With respect to union and public pension fund sponsorship of shareholder proposals under existing law, Roberta Romano observes that:
Bebchuk elsewhere has dismissed such concerns as unwarranted, claiming that ?a shareholder-initiated proposal for a change that would likely be value-decreasing would be highly unlikely to obtain majority support? and that a shareholder therefore could not use such a proposal to ?blackmail management.? In still other work, however, Bebchuk has claimed that because members of the board of directors own such a small percentage of the stock of the company they will agree to value-reducing executive pay packages because the private benefits they reap from remaining in control exceed the lost value of their stock. I?m skeptical of the merits of that argument, but if it is true of executive compensation, wouldn?t it also be true of value-decreasing shareholder proposals? Indeed, he claims that empowering shareholders will produce ?benefits in large part by influencing management?s behavior rather than by leading to actual interventions.?
Granted, Bebchuk seemingly anticipates this argument by suggesting that these indirect benefits accrue only when managers expect a proposal to pass a shareholder vote. Accordingly, the majority vote rule ensures that managers will not be subject to blackmail by a rent-seeking proposal advanced by an institution seeking private benefits because management knows such a proposal will not pass. There are several reasons, however, to believe that Bebchuk over-estimates the extent to which the majority vote requirement insulates the board and management from being blackmailed.
In the first place, people who are risk averse by definition will seek to avoid a loss even if the event in question has a positive expected value. As Bebchuk puts it, managers ?prefer not to lose votes? and, as he has put it elsewhere, ?managers are risk-averse.? Accordingly, managers may still give in to blackmail even where an objective analysis suggests the proposal has little chance of passage.
Second, there are several situations in which a rent-seeking proposal plausibly could threaten to achieve majority support. The rent seeking institution might propose a value-increasing change, for example, which it will agree to drop in exchange for some private benefit. Bebchuk concedes this possibility, but dismisses it on grounds that ?a blackmail argument can be made not only against increasing shareholders? power, but also against maintaining the power that shareholders currently have,? which no one proposes reducing on this account. It?s not clear, however, why the absence of proposals to further disempower shareholders necessarily provides a case for granting them extensive new powers. His argument also seems inconsistent with his claim elsewhere in the article that it is ?not the case? that the ?shareholder veto can ensure decisions regarding basic governance arrangements will be made in the interests of shareholders.?
Alternatively, an institution seeking private benefits could bundle a value-increasing and value-decreasing proposal in hopes of increasing the prospects of passage. The institution also might offer side payments to other institutions. In lieu of side payments, the institution might seek to assemble a coalition of other institutions that would also receive private benefits, which is perhaps the most likely scenario in which an investor coalition would coalesce.
Accordingly, the majority vote requirement is an inadequate constraint on rent seeking by union and public pension funds (or other institutional investors, such as hedge funds, for that matter). To be sure, like any other agency cost, the risk that management will be willing to pay private benefits to an institutional investors is a necessary consequence of vesting discretionary authority in the board and the officers. It does not compel the conclusion that we ought to limit the board?s power. It does, however, suggest that we ought not give investors even greater leverage to extract such benefits by further empowering them.
EA has declined to include the proposal and Bebchuk has sued (where's he getting the money to finance his multiple lawsuits against corporations is a question for a good investigative reporter). The case is now before a US District Court in New York.RESOLVED that stockholders of Electronic Arts, Incorporated recommend that the Board of Directors, to the extent consistent with its fiduciary duties, submit to a stockholder vote an amendment to the Corporation?s Certificate of Incorporation or the Corporation?s Bylaws that states that the Corporation (1) shall, to the extent permitted by law, submit to a vote of the stockholders at an annual meeting any Qualified Proposal to amend the Corporation?s Bylaws; (2) shall, to the extent permitted by law, include any such Qualified Proposal in the Corporation?s notice of an annual meeting of the stockholders delivered to stockholders; and (3) shall, to the extent permitted by law, allow stockholders to vote with respect to any such Qualified Proposal on the Corporation?s proxy card for an annual meeting of stockholders. ?Qualified Proposals? refer in this resolution to proposals satisfying the following requirements:
(a) The proposal was submitted to the Corporation no later than 120 days following the Corporation?s preceding annual meeting by one or more stockholders (the ?Initiator(s)?) that (i) singly or together beneficially owned at the time of submission no less than 5% of the Corporation?s outstanding common shares, (ii) represented in writing an intention to hold such shares through the date of the Corporation?s annual meeting, and (iii) each beneficially owned continuously for at least one year prior to the submission common shares of the Corporation worth at least $2,000.00;
(b) If adopted, the proposal would effect only an amendment to the Corporation?s Bylaws, and would be valid under applicable law;
(c) The proposal is a proper action for stockholders under state law and does not deal with a matter relating to the Corporation?s ordinary business operations;
(d) The proposal does not exceed 500 words; and
(e) The Initiator(s) furnished the Corporation within 21 days of the Corporation?s request any information that was reasonably requested by the Corporation for determining eligibility of the Initiator(s) to submit a Qualified Proposal or to enable the Corporation to comply with applicable law.
Jeff Gordon has a post linking all the briefs and discussing the key issues. Gordon Smith and Larry Ribstein have also posted on the case, as I have (see below).
The case has attracted a lot of attention, including several amicus briefs. Among the amici curiae is a group of 46 corporate and securities law professors, most hailing from elite schools. (Oddly enough, I was not asked to sign, despite being one of the 100 most influential people in corporate governance. :coolsmirk: ) Their brief focuses not on the substantive issues raised by the proposal, but on the initial question of whether EA is legally obliged to include the proposal on its proxy statement.
I recognize that those who signed the brief are not necessarily endorsing Bebchuk's proposal. At the very least, however, they are enabling Bebchuk's activist campaign.
Many of the 46 are friends of mine, for whom I have both affection and respect, so I criticize them with some trepidation, but they're advancing a pernicious cause.
Let us assume the following:
- The proposal passes
\t\t - EA’s board agrees to put the proposed amendment to the articles on the ballot
\t\t - The amendment passes
The Ave Maria funds put forward a proposal to amend the bylaws in a way that would require EA to stop making games rated for mature audiences.
In the absence of Bebchuk's proposal, it's uncertain whether the proposal could be excluded from the proxy statement if management objected. The company will argue (1) that the proposal can be excluded under 14a-8(i)1), because it is not a proper subject for shareholder action. There is a well known conflict in the Delaware code between the sections governing bylaws (109) and the powers of the board (141). The recent CA case suggests that, at least in some cases, the director primacy norms embedded in section 141 trump shareholder rights to adopt bylaws. Likely, this would be the case with respect to a bylaw that tried to preclude the corporation from engaging in a certain line of business.
The company will also argue that (2) the proposal can be excluded under the economic significance test in Rule 14a-8(i)(5) and the ordinary business exception in Rule 14a-8(i)(7). The trouble with this argument will be that the SEC has allowed proposals, such as restrictions on advertising by tobacco companies, when they raise social and ethical concerns.
Assume the SEC sided with the company. Many proponents would give up at this point, because they know that going to court will be an expensive proposition and the SEC's support for the company will weigh heavily in the court's analysis. Those who do go to court are likely to lose in short order for precisely that reason. Hence, having the SEC as a referee for the process offers an important gate-keeping function.
Now suppose Bebchuk's amendment passes. The Ave Maria funds make their proposal. The company argues that the fund's proposal is not "a proper action for stockholders under state law," as required by Bebchuk's amendment, because the director primacy rules inherent in section 141 trump the bylaw rights under section 109. The company further argues that the proposal relates "to the Corporation?s ordinary business operations." Finally, the board of directors, in the exercise of its fiduciary duties, decides that the proposal is such a bad idea it should not be put to a vote. (BTW, does the proposal as written contain an adequate fiduciary out? The relevant language would seem to be "to the extent permitted by law" rather than "to the extent consistent with its fiduciary duties," because the latter appears to modify only the initial issue of whether the amendment to the articles should go forward. A question for another day.)
The proponents argue that the terms "proper subject" and "ordinary business" can be interpreted in light of Rule 14a-8 precedents, since the Rule has very similar exclusions. They rely on cases like Lovenheim and Dole, to argue that proposals with ethical and social significance are a "proper subject" and rise above "ordinary business."
Who referees the dispute? Does Bebchuk's proposal allow shareholders to bypass Rule 14a-8 and thereby oust the SEC as referee? As I understand it, the answer is yes.
So if the company excludes the proposal, the proponent(s) will sue. What standard of review applies? Business judgment rule or, because it affects the franchise, Blasius? How much will the litigation cost the company? How long will the litigation take? Under the law in Delaware, shareholders can ask the Chancery Court to order a company to hold an annual shareholders meeting if more than 13 months have passed since the last one. But what if the litigation is preventing the company from completing a definitive proxy statement to solicit shareholders?
How much money, time, and effort will be soaked up to deal with a special interest proposal with almost no chance of passing?
Before you tell me this is a bogus problem, reflect on the long history of social activists using shareholder proposals to advance their pet causes even though the proposals routinely went down to defeat. Bebchuk's proposal will simply encourage this sort of thing.
Alternatively, what if the shareholder/proponent is using a proposal to pursue some sort of private rent-seeking. In my article, Director Primacy and Shareholder Disempowerment and my book The New Corporate Governance in Theory and Practice, I explored that issue, arguing that union and state and local pension funds are both the most active institutions with respect to corporate governance issues and also the institutions most likely to use their position to self-deal?i.e., to take a non-pro rata share of the firms assets and earnings?or to otherwise reap private benefits not shared with other investors. With respect to union and public pension fund sponsorship of shareholder proposals under existing law, Roberta Romano observes that:
This is not just academic speculation. The pension fund of the union representing Safeway workers, for example, used its position as a Safeway shareholder in an attempt to oust directors who had stood up to the union in collective bargaining negotiations. Nor is this an isolated example. Union pension funds tried to remove directors or top managers, or otherwise affect corporate policy, at over 200 corporations in 2004 alone. Union pension funds reportedly have also tried shareholder proposals to obtain employee benefits they couldn?t get through bargaining.It is quite probable that private benefits accrue to some investors from sponsoring at least some shareholder proposals. The disparity in identity of sponsors?the predominance of public and union funds, which, in contrast to private sector funds, are not in competition for investor dollars?is strongly suggestive of their presence. Examples of potential benefits which would be disproportionately of interest to proposal sponsors are progress on labor rights desired by union fund managers and enhanced political reputations for public pension fund managers, as well as advancements in personal employment. ? Because such career concerns?enhancement of political reputations or subsequent employment opportunities?do not provide a commensurate benefit to private fund managers, we do not find them engaging in investor activism.
Bebchuk elsewhere has dismissed such concerns as unwarranted, claiming that ?a shareholder-initiated proposal for a change that would likely be value-decreasing would be highly unlikely to obtain majority support? and that a shareholder therefore could not use such a proposal to ?blackmail management.? In still other work, however, Bebchuk has claimed that because members of the board of directors own such a small percentage of the stock of the company they will agree to value-reducing executive pay packages because the private benefits they reap from remaining in control exceed the lost value of their stock. I?m skeptical of the merits of that argument, but if it is true of executive compensation, wouldn?t it also be true of value-decreasing shareholder proposals? Indeed, he claims that empowering shareholders will produce ?benefits in large part by influencing management?s behavior rather than by leading to actual interventions.?
Granted, Bebchuk seemingly anticipates this argument by suggesting that these indirect benefits accrue only when managers expect a proposal to pass a shareholder vote. Accordingly, the majority vote rule ensures that managers will not be subject to blackmail by a rent-seeking proposal advanced by an institution seeking private benefits because management knows such a proposal will not pass. There are several reasons, however, to believe that Bebchuk over-estimates the extent to which the majority vote requirement insulates the board and management from being blackmailed.
In the first place, people who are risk averse by definition will seek to avoid a loss even if the event in question has a positive expected value. As Bebchuk puts it, managers ?prefer not to lose votes? and, as he has put it elsewhere, ?managers are risk-averse.? Accordingly, managers may still give in to blackmail even where an objective analysis suggests the proposal has little chance of passage.
Second, there are several situations in which a rent-seeking proposal plausibly could threaten to achieve majority support. The rent seeking institution might propose a value-increasing change, for example, which it will agree to drop in exchange for some private benefit. Bebchuk concedes this possibility, but dismisses it on grounds that ?a blackmail argument can be made not only against increasing shareholders? power, but also against maintaining the power that shareholders currently have,? which no one proposes reducing on this account. It?s not clear, however, why the absence of proposals to further disempower shareholders necessarily provides a case for granting them extensive new powers. His argument also seems inconsistent with his claim elsewhere in the article that it is ?not the case? that the ?shareholder veto can ensure decisions regarding basic governance arrangements will be made in the interests of shareholders.?
Alternatively, an institution seeking private benefits could bundle a value-increasing and value-decreasing proposal in hopes of increasing the prospects of passage. The institution also might offer side payments to other institutions. In lieu of side payments, the institution might seek to assemble a coalition of other institutions that would also receive private benefits, which is perhaps the most likely scenario in which an investor coalition would coalesce.
Accordingly, the majority vote requirement is an inadequate constraint on rent seeking by union and public pension funds (or other institutional investors, such as hedge funds, for that matter). To be sure, like any other agency cost, the risk that management will be willing to pay private benefits to an institutional investors is a necessary consequence of vesting discretionary authority in the board and the officers. It does not compel the conclusion that we ought to limit the board?s power. It does, however, suggest that we ought not give investors even greater leverage to extract such benefits by further empowering them.
