There is a Wall Street aphorism that retail money is dumb money. Retail investors tend to exhibit herd behavior. They also tend not to vote. As shareholder/voters, they tend to be rationally apathetic. Their holdings are so small that their vote will not affect the outcome of a vote, while the time, effort, and opportunity costs of becoming sufficiently informed to make an intelligent decision are high. Hence, they tend just to ignore the voting process.
Up until about ten years ago, this was not much of a problem because most retail shares are held through brokerage accounts and brokers long had the power to vote uninstructed shares. Starting in 2009, however, the NYSE and other major exchanges began restricting the power of brokers to do so. As a result, the percentage of unvoted shares increased dramatically.
At most public companies, especially the largest, the common failure of retail investors to vote was offset by the increasing rise of institutional investors. At many companies the percentage of shares held by institutional investors is 70%+. Indeed, some estimates peg the percentage of the stock market owned by institutional investors at almost 80 percent. Unlike retail investors, institutional investors have legal obligations to vote and access to cost reducing mechanisms such as proxy advisory services.
But then came meme stocks. The SEC defines meme stocks as those whose stock price is driven by bullish retail investors whose choices are highly influenced by social media.
One of the most prominent meme stocks is AMC Entertainment, the movie theater giant. AMC has been battered in recent years by the shift to streaming and, of course, the pandemic. It was a common target of short sellers. In November 2022, AMC stock hit $8 per share, representing a huge loss from the price of $41 per share a year earlier. At this point, however, AMC’s fortunes shifted as if became a meme stock:
Retail investors turned AMC into a meme stock the same way they turned Gamestop into a meme stock. Their reasoning for investing in AMC was a combination of nostalgia, a desire not to see the chain dismantled by bankruptcy, and an attempt to hold the wealthy accountable.
Many of these investors were made up of millennials who fondly remember going to AMC movie theaters to watch movies as kids. They took a stand against losing their favorite movie chain by purchasing shares in large numbers.
Additionally, hedge funds, which are investments that many wealthy people invest in, shorted AMC stock. This means the hedge fund made an investment that makes money when a stock loses value.
AMC’s surging stock price made it possible for management to consider a stock offering to raise equity capital, the proceeds of which could be used to retire debt and enable the company to avoid bankruptcy. But there was a problem—AMC did not have a substantial amount of authorized but unissued shares to sell. The usual solution would be for AMC to ask shareholders to approve an amendment to the articles of incorporation to raise the number of authorized shares. The very thing that held out the prospect of saving AMC—it’s status as a meme stock—now loomed as a major obstacle, because the stock had an unusually high percentage of retail investors. Under Delaware law, an amendment to the article of incorporation requires approval by a majority of the outstanding shares. Since data show that only about 30 percent of shares held by retail investors are voted,[1] it was unlikely AMC would be able to get a quorum at the meeting let alone get the amendment passed.
So AMC embarked on a new strategy. AMC had a blank check preferred stock provision in its articles of incorporation, which the board of directors used to create AMC Preferred Equity units. The ticker name APE was a play on the meme investors who referred to themselves as “apes.” Each APE has 100 votes. The APEs were intended to vote in common with the common shares rather than as a separate class. In addition, the certificate of designation provided that uninstructed APEs would be voted “proportionately with votes cast pursuant to the instructions received from other Holders.” As the plaintiffs in the pending litigation explained, “if the holders of just three APEs cast votes on a corporate proposal—say, two in favor and one against— ComputerShare [the depository agent] will cast votes for all of the nearly 1 billion outstanding APEs 2/3 in favor and 1/3 against, regardless of the number of votes actually cast.”
Some APEs were distributed to the existing common shareholders as a stock dividend; other APEs were sold to investors, primarily to a hedge fund called Antara Capital.
AMC then proposed amending its certificate of incorporation to authorize new common shares, effect a reverse share split of the existing outstanding common stock, and convert the APEs into common shares. The intent was that this series of events would provide a huge amount of new authorized but unissued stock. The effect would be dilutive on the existing common shareholders, however.
As Matt Levine explained in his February 21, 2022, Money Stuff email the plan was likely to succeed:
- There are now many more APEs than common shares, and the APE holders have an incentive to vote yes. (APEs trade at a big discount to common shares, and if the APEs are converted that discount will naturally close.)
- APEs are more likely to be held by professional arbitrageurs, not retail investors, so they are more likely to vote.
- A big block of APEs is held by Antara, which has signed an agreement to vote its shares in favor of the amendment.
- The preferred shares underlying the APEs are held by a depositary, Computershare Trust Co., which has agreed to vote all of the preferred shares in proportion to how any voting APEs vote. So if 20% of the APEs vote yes, 5% vote no, and 75% don’t vote at all, Computershare will vote 80% of the preferred stock for yes, which will be enough to pass the amendments even if all of the common stock doesn’t vote (or votes no).
Allegheny County Employees’ Retirement System brought a class action against AMC and its directors alleging that the “scheme” violated DGCL § 242 by treating the APEs and the common as a single voting class and that the board had violated its fiduciary duties under Blasius.
The Blank Check Preferred
Allegheny County did not object to the certificate of designation and the issuance of the blank checked preferred. If it had done so, it seems unlikely that they would have been successful.
DGCL § 151(g) provides that:
“When any corporation desires to issue any shares of stock of any class or of any series of any class of which the powers, designations, preferences and relative, participating, optional or other rights, if any, or the qualifications, limitations or restrictions thereof, if any, shall not have been set forth in the certificate of incorporation or in any amendment thereto but shall be provided for in a resolution or resolutions adopted by the board of directors pursuant to authority expressly vested in it by the certificate of incorporation or any amendment thereto, a certificate of designations setting forth a copy of such resolution or resolutions and the number of shares of stock of such class or series as to which the resolution or resolutions apply shall be executed, acknowledged, filed and shall become effective, in accordance with §103 of this title.”
Once filed with the state, the certificate of designation has the effect of amending the articles of incorporation.
Article IV Section C of AMC’s certificate of incorporation provides that:
“The Board of Directors is hereby expressly authorized, by resolution or resolutions, to establish, out of the unissued shares of Preferred Stock, one or more series of Preferred Stock and to determine, with respect to each such series, the number of shares constituting such series and the designation of such series, the voting powers (if any) of the shares of such series, and the preferences and relative, participating, optional or other special rights, if any, and any qualifications, limitations or restrictions thereof, of the shares of such series.”
So far so good. But DGCL § 242(b) provides for a vote on an amendment that would “alter or change the powers, preferences, or special rights of the shares of such class so as to affect them adversely.” Allegheny County could have argued that the creation and issuance of the APEs was an amendment to the certificate that reduced their rights and so should have been put to a shareholder vote.
Prior to the issuance of the APEs, the common shared voting rights with no other class of stock. Accordingly, Allegheny County might have argued that the right to vote was a special characteristic of the common stock and the blank check preferred stock therefore required a class vote under § 242(b).
This is a clever argument. As Matt Levine noted, “It is strange to think that boards could issue new shares with unlimited voting power without shareholder approval.”
There seems to be only one relevant precedent: Televest v. Olson (Del. Ch. 1979), which invalidated the use of blank check preferred stock to alter the voting rights of an existing shareholder. But Televest involved a poison pill in which only shares held by someone who owned 20% or more of the stock were effected. The APEs obviously are a very different situation.
But I am not convinced. As Matt Levine observed, if this argument “is right, then that means that boards can never issue voting preferred stock without shareholder approval.” Nothing in the statute or the certificate of incorporation suggests such a limitation.
In addition, § 242(b) is designed to deal with situations where there are already multiple classes of voting stock and to decide whether shares vote by class or as a single group.
Finally, although not a Delaware precent, it is worth noting that the commentary to the MBCA § 10.04, which is the comparable provision, states that a board designation of blank check preferred does not require a shareholder vote and, accordingly, does not trigger class voting.
The Certificate Amendments
Allegheny County had both a statutory and a fiduciary duty argument. The statutory argument rests on § 242(b). DGCL 242(b) provides in pertinent part that:
“The holders of the outstanding shares of a class shall be entitled to vote as a class upon a proposed amendment, whether or not entitled to vote thereon by the certificate of incorporation, if the amendment would increase or decrease the aggregate number of authorized shares of such class . . ..”
“The number of authorized shares of any such class or classes of stock may be increased or decreased (but not below the number of shares thereof then outstanding) by the affirmative vote of the holders of a majority of the stock of the corporation entitled to vote irrespective of this subsection, if so provided in the original certificate of incorporation . . ..”
Balotti and Finkelstein's Delaware Law of Corporations and Business Organizations § 8.11:
Section 242(b)(2) provides that the right to a class vote in the case of an amendment that would decrease or increase the aggregate number of authorized shares of the class may be eliminated by a provision in the certificate of incorporation that authorizes such increase or decrease by the affirmative vote of the holders of a majority of the stock entitled to vote.
Certificate of Incorporation article IV.D:
“The number of authorized shares of any of the Common Stock or the Preferred Stock may be increased or decreased (but not below the number of shares thereof then outstanding) by the affirmative vote of the holders of a majority in voting power of the stock of the Corporation entitled to vote thereon irrespective of the provisions of Section 242(b)(2) of the DGCL (or any successor provision thereto), and no vote of the holders of any of the Common Stock or the Preferred Stock voting separately as a class shall be required therefor.”
Hence, the statutory argument seems pretty weak.
What about the fiduciary duty argument? The core argument is that this was a scheme to end run the voting rights of the common shares.
The key precent is Blasius Industries, Inc. v. Atlas Corp., 564 A.2d 651, 659 (Del. Ch. 1988): “The shareholder franchise is the ideological underpinning upon which the legitimacy of directorial power rests.”
Blasius thus emphasized judicial suspicion of efforts by which “an incumbent board seeks to thwart a shareholder majority.” Id. at 660. “In such a case, the board bears the heavy burden of demonstrating a compelling justification for such action.”
However, Blasius is increasingly “limited to disputes over the election of directors. Accordingly, ‘courts will apply the exacting Blasius standard sparingly, and only in circumstances in which self-interested or faithless fiduciaries act to deprive stockholders of a full and fair opportunity to participate in the matter.’ Of particular significance here, ‘the reasoning of Blasius is far less powerful when the matter up for consideration has little or no bearing on whether the directors will continue in office.’” In re Bear Stearns Litig., 870 N.Y.S.2d 709, 733 (N.Y. Sup. 2008) (citations and footnote omitted).
AMC’s argument here would be that they are not trying to entrench the board in office. Rather the so-called “scheme” is a good faith effort to raise essential equity capital in order to save the company from bankruptcy and that dealing with the known tendency of retail investors to abstain from voting is essential to accomplishing that result. In that regard, it is critical to note that Delaware courts tend to be sympathetic to boards of directors who make what they think is the right decision for their company even if the shareholders don’t like it.
In sum, Blasius can be understood as a “heat of battle” case in which the Delaware Supreme Court simply said that a board engages in inequitable conduct if it changes the rules to a party's disadvantage in the middle of the game (even if the rules would normally be proper). Here, the rules were not changed in the middle of the game. Blasius simply has no application here.
AMC and Allegheny County have entered into a settlement that is now awaiting judicial approval. If the case had gone to trial, I firmly believe that AMC would have prevailed.
A Statutory Fix is Forthcoming
The Delaware legislature is now considering a bill that would, among many other things, amend § 242 to eliminate the need for companies in AMC’s situation to effect such a complicated solution. As the commentary to the bill explains:
Paragraph (d)(1) also provides that no meeting or vote of stockholders is required for an amendment to the certificate of incorporation that reclassifies by subdividing the issued shares of a class of stock into a greater number of issued shares, i.e., a forward stock split, provided that such class is the only class of such corporation’s capital stock then outstanding (and is not divided into series). Paragraph (d)(1) also provides that no vote of stockholders is required, in connection with such subdivision, for such amendment to increase the authorized number of shares of such class, up to an amount proportionate to the subdivision.
Paragraph (d)(2) provides that a corporation listed on a national securities exchange can amend its certificate of incorporation to reclassify by combining the issued shares of a class into a lesser number of issued shares, i.e., a reverse stock split, without obtaining the vote or votes otherwise required by subsection (b) if (i) the shares are listed on a national exchange immediately before the amendment becomes effective and such corporation meets the listing requirement of such exchange relating to the minimum number of holders immediately after the amendment becomes effective, (ii) at a meeting of stockholders at which a vote is taken for and against the proposed amendment, the votes cast for the amendment exceed the votes cast against the amendment and (iii) if the amendment increases or decreases the number of shares of a class of stock that has not opted out of the class vote pursuant to the last sentence of paragraph (b)(2), the votes cast for the amendment by the holders of such class exceed the votes cast against the amendment by the holders of such class. Under the voting standard set forth in paragraph (d)(2)(B) and (C), abstentions have no effect on whether the required approval is obtained.
Richards, Layton and Finger has a good analysis of the changes.
Shoutout
Matt Levine and Chancery Daily have been my go to resources in following this very interesting case. If I have inadvertently quoted them without attribution, please advise and I will immediately correct it. In any cases, if this sort of stuff is of interest, you should be subscribed to them.
[1] Kobi Kastiel & Yaron Nili, In Search of the “Absent” Shareholders: A New Solution to Retail Investors' Apathy, 41 DEL. J. CORP. L. 55, 61-66 (2016).
