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Another Delaware SB 21 drafting problem

The draft statute defines controlling shareholder as someone who, among other things, owns at least 1/3 of the issuer's voting power. Presumably the drafters intend that someone who owns less than 1/3 of the voting stock is not a controlling shareholder and accordingly owes no fiduciary duties to the entity or the other shareholders. But why not say so? What is to stop a court from saying that somebody who owns 20% of the stock and is a superstar CEO is a controller with fiduciary duties? Granted, a fair reading of the statute suggests that the legislative intent is to preclude such cases. But I'm a belts and suspenders guy. So why not explicitly say somebody who owns less than 1/3 is not a controlling shareholder and owes no fiduciary duties to the entity or the other shareholders?

Is Delaware SB 21 the Start of a Race to the Bottom?

Over on LinkedIn, the invaluable  Lauren Pringle of the estimable Chancery Daily wrote of Delaware SB 21:

Make no mistake — this is regressive legislation that races us to the bottom. If you told someone forty years ago in all the “race to the bottom” debates that Delaware would be cribbing from the MBCA and that was nearly the least-bad aspect of proposed DGCL changes that had skipped out on the CLC process and were getting slammed through the legislature in a matter of weeks, no one ever would have believed you. And yet. Here we are.

I'm sort of ambivalent about the process by which SB 21 came to life. On the one hand, I get the argument that Delaware has a historic process that has served it well and has been bypassed here. On the other hand, Delaware's historic process consists of the state bar's corporation law council drafting legislation that the legislature then rubber-stamps. It's not exactly a paragon of democratic virtue. 

In any case, I seriously doubt whether SB 21 is starting a race to the bottom. Let's assume that the bottom is Nevada (no offense to my Nevada friends, but it's true). Serious scholars like Michal Barzuza and Ofer Edlar have closely scrutinized Nevada law and come away concluding that it is "lax." See Michal Barzuza, Market Segmentation: The Rise of Nevada As A Liability-Free Jurisdiction, 98 Va. L. Rev. 935, 942 (2012) (“Nevada leverages its own competitive advantage by offering lax law.”); Ofer Eldar, Can Lax Corporate Law Increase Shareholder Value? Evidence from Nevada, 61 J.L. & Econs. 555, 556 (2018) (“The migration of firms to Nevada seems to be driven by the laxity of its corporate law with respect to managers . . ..”). 

In 2001, for example, Nevada launched an especially aggressive attack on Delaware’s dominance, “as part of a plan to significantly raise franchise taxes for Nevada corporations,” by amending its corporation statute to offer substantially increased protection for managers against liability risk. Bruce H. Kobayashi & Larry E. Ribstein, Nevada and the Market for Corporate Law, 35 Seattle U.L. Rev. 1165, 1170 (2012). 

At the time the amendments were adopted, one Nevada legislator objected that they would “protect some corporate crooks” and come “at a terrible price.”  Dain C. Donelson & Christopher G. Yust, Litigation Risk and Agency Costs: Evidence from Nevada Corporate Law, 57 J.L. & Econs. 747, 753 (2014). Another complained that if the amendments were adopted “corporate officers and directors would be able to ‘commit virtually any act and get away with it and waste your money .... Scoundrels can move here.’”  Id. Overall, critics predicted, the legislation would “impair shareholder litigation rights significantly, and facilitate self-dealing transactions, poor corporate governance practices, and managerial misconduct.” Michal Barzuza, Nevada v. Delaware: The New Market for Corporate Law 6 (Mar. 2024), https://papers.ssrn.com/sol3/papers.cfm?abstract_id=4746878. 

Delaware has strong incentives not to race Nevada to the bottom. Unlike Nevada’s focus on a small firm market segment, Delaware caters to “larger firms that pay higher franchise fees.”  Ofer Eldar & Lorenzo Magnolfi, Regulatory Competition and the Market for Corporate Law, 12(2) Am. Econ. J.: Microecon. 60, 81 (2020). Those firms face substantial pressure from large institutional investors who generally dislike Nevada-style liability protection for directors and officers. See Eldar & Magnolfi, supra, at 64 (“Nevada firms tend to be relatively small with low institutional shareholdings, and that Delaware firms tend to be larger and have significant institutional ownership”).

In addition to the constraining influence of institutional investors, venture capitalists reportedly prefer founders to incorporate in Delaware.  See Jennifer Kay, Musk’s Tesla Threats Unlikely to Shake Delaware’s Dominance, Bloomberg News (Apr. 2, 2024), https://news.bloomberglaw.com/litigation/musks-tesla-threats-unlikely-to-shake-delawares-dominance (“Often it’s venture capital firms and other investors who push for Delaware incorporation . . ..”). Likewise, activist investors pressuring incumbent directors to improve firm performance reportedly often include reincorporation into Delaware among their demands.  Eldar & Magnolfi, supra, at 65.

In order to placate such investors, firms with such investors are unlikely to opt for a Nevada-like regime. In turn, to placate such firms, Delaware is unlikely to increase the laxity of its laws to match Nevada. 

Another important constraint on Delaware’s ability to pursue Nevada-style laxity is the risk of federal intervention. There is an emerging consensus that Delaware’s chief competition is no longer other states but rather the federal government.  Although the federal government typically intervenes in corporate governance only in response to financial crises,  Delaware is nevertheless highly aware of the threat of federal preemption.  Former Delaware Chief Justice Norman Veasey, for example, has repeatedly warned that Congress may preempt Delaware law if Delaware courts fail to uphold its fiduciary duty standards.

Noting these developments, Professor Barzuza argues an effort by Delaware to compete with Nevada by weakening shareholder protections might trigger federal intervention. Barzuza, supra, at 967. Given Delaware’s reliance on maintaining its franchise tax revenue, Delaware cannot risk federal preemption.  In contrast, because Nevada corporate law does receive the same level of attention as paid to Delaware law, Nevada’s laxity poses a much lower risk of triggering federal intervention.

This post draws on Bainbridge, Stephen Mark,  DExit Drivers: Is Delaware's Dominance Threatened? (July 29, 2024). UCLA School of Law, Law-Econ Research Paper No. 24-04, Available at SSRN: https://ssrn.com/abstract=4909689

A Comment on Larry Cunningham's Weinberg Center Program on SB 21: Would Tornetta Come Out the Same Way?

Larry Cunningham held a program on Delaware SB 21 yesterday at the University of Delaware's Weinberg Center. He summarized the speakers on Linkedin.

One speaker was Ed Rock (regular readers will recall he is the Chief Reporter of the ALI's pending Restatement of Corporate Governance). 

Professor Rock highlighted that the Musk pay cases (Tornetta I and II) would come out the same way under a pending bill in the Delaware legislature aimed at altering the state's approach to assessing controlling stockholder transactions since the bill doesn't address conflicted CEO transactions, while also observing that the bill seems to respond to pressures from other non-majority controlling stockholders seeking to weaken constraints on their control.

Yale law professor Jon Macey called this summation to my attention and kindly allowed me to take it up on the blog. We're trying to figure out why Professor Rock thinks the cases would come out the same way under SB 21. 

I think it's possible that it would come out the same way, but I think it is far from certain and that a strong argument can be made it would come out differently.

I start with the premise that Tornetta v. Musk was the decision that triggered SB 21. After his $50 billion-plus compensation plan was struck down by the Delaware Chancery Court,  Musk fired off a now notorious social media post recommending that one should “[n]ever incorporate your company in the state of Delaware.”  Tesla subsequently reincorporated in Texas. Subsequently, other controllers started making noises about moving, which triggered Delaware to respond with SB 21 to provide controllers with greater insulation from liability. Presumably the drafters would have ensured that the triggering case would be covered by the statute.

Let's look at SB 21. The first question raised under the statute is whether Musk would be deemed a controlling shareholder. SB 21 defines a controlling shareholder as

any person that, together with such person’s affiliates and associates:

a. Owns or controls a majority in voting power of the outstanding stock of the corporation entitled to vote generally in the election of directors; or

b. Has the power functionally equivalent to that of a stockholder that owns or controls a majority in voting power of the outstanding stock of the corporation entitled to vote generally in the election of directors by virtue of ownership or control of at least one-third in voting power of the outstanding stock of the corporation entitled to vote generally in the election of directors or for the election of directors who have a majority in voting power of the votes of all directors on the board of directors and power to exercise managerial authority over the business and affairs of the corporation.

According to the Tornetta decision, at the relevant point in time, Musk owned "approximately 21.9% of Tesla's outstanding common stock." Tornetta v. Musk, 310 A.3d 430, 502 (Del. Ch. 2024). As I read SB 21, it is not enough for Musk to exercise de facto "managerial authority over the business and affairs of the corporation," he must also own at least 1/3 of the stock. As the MNAT memorandum on SB 21 explains:

... for non-majority stockholders to be considered controlling stockholders, the functionally-equivalent-to-majority power must be by virtue of ownership or control of at least one-third in voting power of the outstanding stock of the corporation entitled to vote (i) generally in the election of directors or (ii) for the election of directors who have a majority in voting power of the votes of all directors on the board of directors. This change would prevent the existence of controlling stockholder status from being found if the alleged controller does not own a minimum level of stock.

And Musk does not meet that minimum.

Of course, Musk is a CEO. As such, his pay package could be viewed as a related party transaction of the sort traditionally subject to review under DGCL 144. Contrary to what Professor Cunningham reports Professor Rock as stating, it is incorrect to say the bill does not address conflicted CEO transactions. It makes some important changes in former section 144(a) as applied to conflict of interest transactions involving directors and officers. 

As revised by SB 21 (assuming it passes), a transaction between the corporation and one of its officers:

may not be the subject of equitable relief, or give rise to an award of damages or other sanction against a director or officer of the corporation if: (1) The material facts as to the director’s or officer’s relationship or interest and as to the contract act or transaction transaction, including any involvement in the initiation, negotiation, or approval of the act or transaction, are disclosed or are known to the board of directors or the committee, and the board or committee in good faith authorizes the contract act or transaction by the affirmative votes of a majority of the disinterested directors, even though the disinterested directors be less than a quorum ....

As I read that statute, Musk's pay package would have been insulated from review if a single member of the Tesla board of directors qualified as "disinterested."

SB 21 defines a disinterested director as "a director who is not a party to the act or transaction and does not have a material interest in the act or transaction or a material relationship with a person that has a material interest in the act or transaction." In turn, material relationship is defined as "a familial, financial, professional, employment, or other relationship that (i) in the case of a director, would reasonably be expected to impair the objectivity of the director’s judgment when participating in the authorization or approval of the act or transaction at issue ...."

Hence, disinterested includes independence. Granted, McCormick found that all of the Tesla directors had relationships with Musk. She basically said none of them were independent, albeit to varying degrees. 

But SB 21 adds a wrinkle to the analysis. It provides that: 

Any director of a corporation that has a class of stock listed on a national securities exchange shall be presumed to be a disinterested director with respect to an act or transaction to which such director is not a party if the board of directors shall have determined that such director is an independent director or satisfies the relevant criteria for determining director independence under any rules promulgated by such exchange, which presumption shall be heightened and may only be rebutted by substantial and particularized facts that such director has a material interest in such act or transaction or has a material relationship with a person with a material interest in such act or transaction.

Assuming NASDAQ qualifies as a national securities exchange, the directors would get the benefit of this "heightened" presumption. McCormick would have to find "substantial and particularized facts" to rebut that presumption. Obviously, her opinion did not have to resolve that issue, so we have to speculate as to how the analysis would come out under the new presumption.

As to at least two directors--Denholm and Buss--"Plaintiff does not argue that Musk established Buss and Denholm's compensation so as to render them beholden." Tornetta v. Musk, 310 A.3d 430, 510 (Del. Ch. 2024). That's a key factor. After all, if you're not beholden, you're generally regarded as independent. 

McCormick nevertheless claimed that Denholm and Buss's lack of independence could be shown by examining how they "acted when negotiating the Grant." Id. There are two problems with that argument, however. First, the part of her opinion analyzing the negotiations makes virtually no mention of Denhold and Buss. Second, McCormick's analysis is premised on her view that establishing Musk was a controller with respect to the transaction at issue is sufficient. See id. at 511 ("There is no greater evidence of Musk's status as a transaction-specific controller than the Board's posture toward Musk during the process that led to the Grant."). It is true that transaction specific control was sufficient under the pre-SB 21 common law. But as we have seen SB 21 says that a minority stockholder can only be deemed a controller if it owns 1/3 of the stock and "power to exercise managerial authority over the business and affairs of the corporation." I read that language as precluding transaction specific control.

In sum, so long as at least one Tesla director qualifies as disinterested, Musk's transaction is cleansed. Given the "heightened" presumption and the narrowed definition of material relationship, I suspect that at least Denholm or Buss would so qualify if the case were tried under the new standard. 

Update: Professor Rock sent along some comments, which he kindly allowed me to post:

Larry’s one sentence summary, not reviewed by me, missed a bit of the nuance but was mostly accurate.  I’m glad to see that you (mostly) agree with me. While you are right that new 144 would allow a single disinterested & independent director to approve an officer/director conflict transaction (which is weird), surely there was enough evidence in KSJM’s post trial opinion to give her the grist, should she have wanted to use it, to conclude that none of the directors was disinterested.  In the litigation context, as you pointed out, she didn’t have to, but it was there.  I am enough of a legal realist to think that how a judge justifies his/her decision is not necessarily how he/she arrived at it!

A Question About Delaware SB 21 and Fairness

As I have been doing, my friend Yale law professor Jon Macey has been following developments with respect to Delaware SB 21 closely. He posed a question that I found quite interesting and kindly gave me permission to pass it along to my readers.

SB 21 defines "fair to the corporation" as:

... the act or transaction at issue, as a whole, is beneficial to the corporation, or its stockholders in their capacity, as such given the consideration paid to or received by the corporation or its stockholders or other benefit conferred on the corporation or its stockholders and taking into appropriate account whether the act or transaction meets both of the following:

a. It is fair in terms of the fiduciary’s dealings with the corporation.

b. It is comparable to what might have been obtained in an arm’s length transaction available to the corporation.

It's not clear to me what work this provision does. As I explain in my article on SB 21, A Course Correction for Controlling Shareholder Transactions available at SSRN: https://ssrn.com/abstract=5022685, the common law defines fairness as having two components: fair dealing and fair price.  The former goes to the process by which the transaction was proposed, approved, and consummated.  The latter goes to the economics of the transaction.  The review is not neatly bifurcated; rather, all aspects of the transaction must be considered together. 

Accordingly, it seems as though SB 21 essentially tracks the existing common law. So why include it in the statute? What did the drafters intend?

One guess is that they don't want courts changing the definition of fairness so as to end run the statutory intent to insulate conflicted controlled transactions. But that doesn't make sense because SB 21 allows cleansing by disinterested directors or shareholders without regard to whether the transaction is fair. Fairness only comes into play as an alternative way of cleansing a conflicted transaction.

So I'm puzzled.

Could the Chancery Court End-Run SB 21?

The Delaware Supreme Court held in Schnell v. Chris-Craft Industries, Inc., that “inequitable action does not become permissible simply because it is legally possible.” This means that even if a corporate action complies with the literal terms of a statute, Delaware courts can intervene if the action is deemed unfair or inequitable. Schnell thus demonstrates that Delaware courts will not allow statutory formalism to justify unfair corporate behavior. Equity acts as a safeguard against directors exploiting statutory provisions to the detriment of shareholders. The decision remains a cornerstone of Delaware’s approach to corporate governance, ensuring that statutory compliance is always subject to equitable scrutiny. It’s at least conceivable that an activist judge could invoke Schnell to impose liability in a particular case even though the technical requirements of SB 21 were satisfied.

But there's a sticking point. Note that SB 21 says that acts by directors, officers, and controlling shareholders may not, inter alia, "be the subject of equitable relief" if appropriate cleansing actions are taken. Does that foreclose the Schnell end-run? It depends on what you think "equitable relief" means. If you think it means that any relief granted pursuant to the court's exercise of its inherent equitable powers under Schnell is "equitable relief," then the end run likely won't work. But is there another reading?

Professor Talley Poses a SB 21 Question: I resort to AI

Over on LinkedIn, my friend and fellow corporate law prawf Eric Talley poses a thought question about new Delaware SB 21, about which I have been blogging extensively:

A new and historically significant set of proposed Delaware corporate law reforms dropped yesterday (see my hot take here: https://lnkd.in/eqZtfDBq ). The proposed reforms are significant and worthy of substantive debate (which I hope and expect they will receive). One of the proposed measures will overturn the 2024 Match Group opinion, which applied a uniform standard to cleansing controller conflicts. Instead, the proposal would materially reduce judicial scrutiny on conflicted controller acts *except* for "squeeze-outs" (controller going-private transactions where all or substantially all of minority stockholders' shares are transferred to the controller or eliminated). Such squeeze-out transactions would still be subject to the MFW "belt and suspenders" cleansing test (albeit in now weaker form). This was the same carve-out that was (unsuccessfully) asserted in the Match Group case, and it reminded me of a challenge I gave to my M&A students at the time.

HERE IS THE CHALLENGE: Your client is a Delaware corporation with a controller. Design a conflicted controller transaction structure for your client that is *technically not* a controller squeeze-out (per the above definition), but accomplishes substantially the same economic effects, thereby giving the controller a hall pass under the proposal, allowing them to evade 2-level cleansing / heightened judicial scrutiny. For the "best" entry I will send (at my own cost) a much coveted "I <3 Corporations" t-shirt (the same type that I have been known to throw out to my students in a shameless gesture of pedagogical pandering). 1, 2, 3, Go!

As regular readers know, I've been blogging and tweeting up a storm about SB 21 and I'm feeling tired. Also, it's almost dinner time. So I dumped the question onto "Larry The Scholarly Legal Writing Instructor" at ChatGPT developed by my good friend JW Verret. Here's Larry's answer:

To structure a conflicted controller transaction that avoids classification as a "squeeze-out" under SB 21—while still achieving similar economic effects—a controller could implement a Minority Stockholder Migration & Reclassification Strategy. This would avoid triggering the MFW two-step cleansing requirement while materially reducing judicial scrutiny. Here’s how:

Step 1: Controller Purchases Minority Shares on the Open Market

• The controller gradually acquires a substantial portion of minority-held shares via open-market purchases and negotiated private transactions.
• Since these are voluntary sales, the transaction avoids being classified as a squeeze-out or mandatory elimination of minority interests.
• Delaware courts have historically been hesitant to impose entire fairness scrutiny on mere open-market acquisitions by controllers.

Step 2: Creation of a New Non-Voting Class & Reclassification

• The company adopts a charter amendment (approved by a controller-majority board and ratified via majority vote, where the controller holds effective control).
• The amendment reclassifies the remaining minority shares into a new class of non-voting, illiquid, or otherwise economically impaired stock (e.g., non-transferable, dividend-subordinate, or convertible into a different class only under controller-defined terms).
• Courts have sometimes declined to treat reclassification as a per se squeeze-out if shares technically continue to exist, especially when framed as an internal corporate governance matter.

Step 3: Issuance of Special Dividend / Asset Transfer to a New Entity

• The company issues a special dividend in the form of a security or cash distribution, available only to holders of the original common stock (which the controller exclusively holds after Step 2).
• Alternatively, the company transfers valuable assets to a new entity in which the controller has disproportionate ownership or control, leaving the reclassified minority stockholders with shares in a hollowed-out corporate shell.
• Since minority stockholders technically retain shares, this avoids the formal "elimination" trigger under SB 21's squeeze-out definition.

Step 4: Subsequent Tender Offer or Buyout at Depressed Prices

• Once the reclassification and economic dilution have been implemented, the controller offers to buy out remaining minority holders at a heavily discounted price (since their shares are now structurally inferior).
• At this stage, the remaining minority shareholders are effectively coerced into selling, as their equity position is functionally worthless.

Legal Positioning & Justification

• The controller avoids the "squeeze-out" label because:
  1. No forced elimination of all or substantially all minority shares. Instead, shares remain outstanding but economically impaired.
  2. No direct cash-out merger or similar structured buyout. The transactions occur through market purchases, reclassification, and asset transfers.
  3. Tender offer is nominally voluntary. While practically coercive, the offer does not require minority holders to tender their shares.

End Result: Economic Equivalent of a Squeeze-Out, Without Heightened Scrutiny

This structure achieves nearly identical economic effects as a formal controller squeeze-out while avoiding SB 21’s strict MFW requirements. By relying on piecemeal steps (open-market purchases, charter amendments, asset shifts, and coercive tender offers), the controller evades the two-level cleansing process, ensuring a hall pass under the proposed lower scrutiny framework.

So then I decided to see what Claude would do with it. Here's his answer:

Controller Asset Extraction Strategy

The controller could implement a multi-step transaction that:

1. Creates a wholly-owned subsidiary ("HoldCo")
2. Transfers substantially all valuable assets from the controlled public company ("PublicCo") to HoldCo
3. Leaves the public minority shareholders with technically intact ownership, but in a hollowed-out entity

Transaction Structure Details

Step 1: Strategic Asset Identification and Transfer

• The controller identifies PublicCo's most valuable assets/operations
• PublicCo transfers these assets to HoldCo in exchange for HoldCo debt instruments
• The debt is structured with minimal interest, extremely long maturity, and subordinated status

Step 2: Management Agreement

• HoldCo enters into a management agreement with PublicCo
• The agreement grants HoldCo complete operational control of remaining PublicCo assets
• Management fees are set at levels that extract nearly all future free cash flow

Step 3: Capital Structure Reconfiguration

• PublicCo issues a special dividend-in-kind of the HoldCo debt to the controller only
• This is structured as a non-pro rata distribution to the controller class of stock
• Alternatively, PublicCo issues new preferred stock with liquidation preference approximating enterprise value

Step 4: Operational Stranglehold

• PublicCo enters into exclusive supply/distribution agreements with controller affiliates
• Terms are structured to transfer economic value from PublicCo to controller entities
• May include trademark licenses that can be terminated, making PublicCo wholly dependent

Legal Analysis

This structure avoids being a technical "squeeze-out" because:

1. No shares are being transferred to the controller
2. No shares are being eliminated
3. Minority shareholders retain their exact same percentage ownership
4. PublicCo remains a public entity with technically viable operations

Yet economically, this achieves the squeeze-out effect by:

1. Stripping economic value from the public entity
2. Transferring future value creation potential to controller-owned entities
3. Leaving minority shareholders with shares that have minimal economic value
4. Creating practical impossibility for minority shareholders to realize value

This structure exploits the narrowly drafted definition of "squeeze-out" in the proposed legislation while accomplishing substantively identical economic results, thereby evading the cleansing requirements.

I'm going to stop and go make dinner. I'll invite Eric to drop by and leave his thoughts in the comment section, although he'll probably just say something snarky about my letting AI do my work for me.

Delaware SB 21 and Director and Officer Conflict of Interest Transactions: The Good, the Bad, and the Missed Opportunities

This post is now available at CLS Blue Sky Blog.

Anthony Rickey on SB 21

Excellent article by Anthony Rickey on Delaware SB 21. Hint: It's about more than Elon Musk. www.linkedin.com/pulse/reform...

[image or embed]

— Stephen Bainbridge (@prawfbainbridge.bsky.social) February 19, 2025 at 12:22 PM

My article "A Course Correction for Controlling Shareholder Transactions" updated to reflect SB 21

In a post yesterday, I discussed my preliminary reactions to Delaware SB 21, which will modify Delaware's rules governing conflicted controller transactions. The changes being made are largely consistent with the changes I proposed in my article, A Course Correction for Controlling Shareholder Transactions, available at SSRN: https://ssrn.com/abstract=5022685.

I've now had a chance to update the article to reflect SB 21 and to compare my proposals to what the Delaware legislature is considering. The revised article is now available for downloading from SSRN at the link above.

In general, I support SB 21.

My main concern is with the definition of conflicted controller transaction in the bill, which is both under- and over-inclusive.

SB 21 defines a controlling shareholder transaction as “an act or transaction between the corporation or 1 or more of its subsidiaries, on the one hand, and a controlling stockholder or a control group, on the other hand, or an act or transaction from which a controlling stockholder or a control group receives a financial or other benefit not shared with the corporation’s stockholders generally.” As such, it is likely to capture a much wider set of cases than the proposal I offered in my article--i.e., a revitalized Sinclair Oil test under which a controller transaction only triggers entire fairness review (i.e., is deemed to involve self-dealing) if the controller receives a benefit that comes at the expense of and to the exclusion of the minority.

SB 21 captures all transactions between a controller and the controlled entity. Like current law it thus will treat many ordinary controller—controlled entity transactions as being conflicted even though they are common commercial transactions. Sinclair Oil’s threshold test was specifically designed to prevent just that result. My article argues that the Sinclair Oil court was correct to do so. Second, and more importantly, SB 21 treats any controller transaction in which the controller receives a benefit to the exclusion of the minority as conflicted. Under Sinclair Oil, however, a transaction is only deemed conflicted if the controller’s benefit comes both to the exclusion of and at the expense of the minority. As I argue in my article, both elements are essential to an optimal standard.

On the other hand, SB 21’s definition does not capture an important category of cases; namely, those between subsidiaries of a parent corporation. In Sinclair Oil, the transaction between Sinven and International was subjected to entire fairness review. Even though Sinclair Oil was not a party to the contract, it received a benefit from the transaction through its control of International. Because International was a wholly-owned subsidiary of Sinclair Oil, the parent benefited both at the expense of and to the exclusion of the minority. For the reasons explained in my article, Delaware law needs to continue applying entire fairness to such transactions.

Preliminary Reaction to Delaware SB 21 and Comparison to the Proposals I Made in A Course Correction for Conflicted Controller Transactions

In my article, A Course Correction for Controlling Shareholder Transactions, available at SSRN: https://ssrn.com/abstract=5022685, I argue that Delaware courts increasingly exhibit a reflexive suspicion of transactions involving a controlling shareholder.  The court has operationalized that skepticism by notably broadening the definition of who qualifies as a controlling shareholder. In particular, the courts are increasingly willing to hold that shareholders who own less than a majority of the corporation’s voting power nevertheless possess control.  Taken to its logical extreme, this trend easily could result in someone being deemed a controller even in the absence of stock ownership. 

The court’s growing skepticism of controlling shareholders is further reflected in its tightening of the standards governing the conduct of controlling shareholders.   In doing so, the court has expanded the range of conflicted transactions necessitating cleansing and heightened the rigor with which cleansing standards are applied, particularly regarding the criteria for independent directors.

My article contends that Delaware courts need a course correction. They have pushed the law governing controlling shareholders far beyond legitimate policing into unnecessary and unwise overregulation. This has prompted a backlash in which controllers threaten to reincorporate outside of Delaware, following Elon Musk’s example of moving Tesla to Texas.

I propose four course corrections, pursuant to which the courts: (1) should narrow the definition of controller; (2) should not attempt to sort out in which cases controllers owe fiduciary duties to the minority from those in which they do not, but instead hold that a controller always owes fiduciary duties to the minority;  (3) narrow the class of cases under which entire fairness is the standard of review by adopting a reinvigorated Sinclair Oil threshold test under which entire fairness is triggered only when the controller receives a benefit at the expense of and to the exclusion of the minority; and (4) improve the regime for cleansing transactions in which entire fairness applies. These changes will reduce costs and encourage beneficial investment, while also enhancing Delaware’s position as the state of choice for incorporation. Accordingly, if the courts fail to adopt them, the Delaware legislature should consider doing so by statute.

The Delaware legislature has now undertaken just such a reform effort. Newly introduced SB 21 is largely consistent with the proposals I make in my article. In this post, I highlight the key changes:

SB 21 creates new DGCL § 144(e)(2), which defines controlling shareholder as:

[A]ny person that, together with such person’s affiliates and associates: Owns or controls a majority in voting power of the outstanding stock of the corporation entitled to vote generally in the election of directors; or

Has the power functionally equivalent to that of a stockholder that owns or controls a majority in voting power of the outstanding stock of the corporation entitled to vote generally in the election of directors by virtue of ownership or control of at least one-third in voting power of the outstanding stock of the corporation entitled to vote generally in the election of directors or for the election of directors who have a majority in voting power of the votes of all directors on the board of directors and power to exercise managerial authority over the business and affairs of the corporation.^[1]

Like my proposal, SB 21 creates a presumption of control for holders of a majority of the corporation’s voting power. As for minority shareholders, SB 21’s functional equivalence language likely would lead to the same results as my practical certainty proposal. Finally, also like my proposal, SB 21 requires stock ownership, but goes further by supplementing the functional equivalence standard by creating a brightline rule by requiring a controller to own at least one-third of the company’s voting power.

We come now to a couple of provisions that are inconsistent with my proposals and, as matter of good policy, need to be revised. SB 21 defines a controlling shareholder transaction as “an act or transaction between the corporation or 1 or more of its subsidiaries, on the one hand, and a controlling stockholder or a control group, on the other hand, or an act or transaction from which a controlling stockholder or a control group receives a financial or other benefit not shared with the corporation’s stockholders generally.”[2] As such, it is likely to capture a much wider set of cases than the foregoing proposal. First, it captures all transactions between a controller and the controlled entity. Like current law it thus will treat many ordinary controller—controlled entity transactions as being conflicted even though they are common commercial transactions. Sinclair Oil’s threshold test was specifically designed to prevent just that result. My article argues that the Sinclair Oil court was correct to do so. Second, and more importantly, SB 21 treats any controller transaction in which the controller receives a benefit to the exclusion of the minority as conflicted. Under Sinclair Oil, however, a transaction is only deemed conflicted if the controller’s benefit comes both to the exclusion of and at the expense of the minority. As we shall see below, both elements are essential to an optimal standard.

On the other hand, SB 21’s definition does not capture an important category of cases; namely, those between subsidiaries of a parent corporation. In Sinclair Oil, the transaction between Sinven and International was subjected to entire fairness review.[3] Even though Sinclair Oil was not a party to the contract, it received a benefit from the transaction through its control of International.[4] Because International was a wholly-owned subsidiary of Sinclair Oil, the parent benefited both at the expense of and to the exclusion of the minority.[5] For the reasons explained in my article, Delaware law needs to continue applying entire fairness to such transactions.

Returning to changes with which I concur, SB 21 modifies the MFW cleansing standard in a number of ways. First, it treats going private transactions differently from all other conflicted controller transactions.[6] As for the latter, it allows cleansing via either MFW prong.[7]

In this regard, SB 21 appears to have been heavily influenced by Hamermesh, Jacobs, and Strine’s article. They proposed limiting MFW to the going private context, [8] which SB 21 does. They proposed allowing other conflicted controller transactions to be cleansed using either “of the traditional cleansing techniques”—i.e., approval by disinterested directors or disinterested shareholders[9]—which SB 21 also does. In one respect, however, SB 21 goes beyond what Hamermesh, Jacobs, and Strine proposed. They argued for eliminating what they called the “vestigial waste claim” if a transaction were approved by the disinterested shareholders, while retaining it if a transaction was approved by the disinterested directors.[10] In contrast, as discussed above, my proposal would eliminate the waste claim in either case. SB 21 adopts the latter approach, providing with respect to both types of controller transactions that they “may not be the subject of equitable relief, or give rise to an award of damages or other sanction against a director or officer of the corporation or any controlling stockholder or member of a control group, by reason of a breach of fiduciary duty by a director, officer, controlling stockholder, or member of a control group, if” cleansed as per the statutory requirements.[11]

SB 21 also addresses the Chancery Court’s cramped definition of director independence, providing reforms comparable to those proposed herein. Several provisions work together to accomplish that result. “Disinterested director” is defined by new § 144(e)(4) to mean “a director who is not a party to the act or transaction and does not have a material interest in the act or transaction or a material relationship with a person that has a material interest in the act or transaction.” The reference to material relationship thus expands disinterestedness to encompass independence. “Material interest” is defined by new § 144(e)(8) as “an actual or potential benefit, including the avoidance of a detriment, other than one which would devolve on the corporation or the stockholders generally, that . . . would reasonably be expected to impair the objectivity of the director’s judgment when participating in the authorization or approval of the act or transaction at issue . . ..”[12] “Material relationship” is defined by new § 144(e)(9) as “ a familial, financial, professional, employment, or other relationship that . . . would reasonably be expected to impair the objectivity of the director’s judgment when participating in the authorization or approval of the act or transaction at issue . . ..”[13]

Although § 144(e)(9)’s reference to “other relationship” might seem to create a loophole through which a court could drive the sort of personal relationships that have bedeviled the analysis in recent years, new § 144(d)(2) includes a presumption tracking that suggested above:

Any director of a corporation that has a class of stock listed on a national securities exchange shall be presumed to be a disinterested director with respect to an act or transaction to which such director is not a party if the board of directors shall have determined that such director is an independent director or satisfies the relevant criteria for determining director independence under any rules promulgated by such exchange, which presumption shall be heightened and may only be rebutted by substantial and particularized facts that such director has a material interest in such act or transaction or has a material relationship with a person with a material interest in such act or transaction.[14]

In sum, these new provisions thus are largely consistent with my proposals. They should provide considerably greater certainty and predictability, while expanding the definition of independence beyond the narrow one towards which the Chancery Court has been moving.

Rethinking Rule 14a-8: A Case for Repeal or Meaningful Reform of the Shareholder Proposal Rule

The shareholder proposal rule, Securities Exchange Act Rule 14a-8, has long been heralded as a democratizing tool in corporate governance, allowing shareholders to voice their concerns through inclusion in company proxy materials. While well-intentioned, Rule 14a-8 is no longer fit for purpose. The rule imposes disproportionate costs on issuers, enables misuse by a small group of activists, and distracts boards from their core fiduciary responsibilities. Attempts at reform have failed to address these systemic flaws. This article argues that Rule 14a-8 should be repealed entirely or, at a minimum, reformed to align with its original purpose while restoring balance to corporate governance.

The History and Evolution of Rule 14a-8

When Congress enacted the Securities Exchange Act of 1934, it delegated substantial authority to the Securities and Exchange Commission (SEC) to regulate proxy solicitation under § 14(a). In 1942, the SEC adopted Rule 14a-8, allowing shareholders to submit proposals for inclusion in company proxy materials, provided the proposals were proper subjects for shareholder action under state law. Over the decades, the rule has been amended repeatedly, expanding both its procedural and substantive reach.

Initially envisioned as a mechanism to enhance shareholder participation, Rule 14a-8 has instead evolved into a tool for a minority of activists to advance agendas often unrelated to the company’s financial performance. This evolution has come at a cost: growing procedural complexity, increased compliance burdens, and the diversion of board attention from strategic priorities.

Flaws in the Current Rule

High Costs and Burdens. The financial and administrative costs associated with Rule 14a-8 are significant. Estimates suggest that a single shareholder proposal can cost a company as much as $150,000 in direct expenses, not including the considerable time and effort required to manage the process. For many companies, these costs disproportionately benefit a small minority of shareholders while providing little value to the broader shareholder base.

Misuse by Activists. Rule 14a-8 is disproportionately utilized by a handful of "corporate gadflies," who submit proposals on personal, political, or social issues rather than matters of economic importance to the company. For instance, data indicate that a mere three individuals or groups account for a substantial portion of shareholder proposals submitted annually.

Moreover, union pension funds and other institutional investors often leverage the rule to advance private agendas, such as labor disputes or political initiatives, rather than promoting shareholder value. These practices deviate from the rule's intended purpose and impose additional costs on the majority of shareholders.

Distraction from Core Responsibilities. Rule 14a-8 also undermines board primacy by forcing directors to engage with proposals that delve into operational matters traditionally reserved for management. This distraction erodes the business judgment rule's protections and detracts from boards' focus on long-term value creation.

Arguments for Repeal

Restoring Board Autonomy. Repealing Rule 14a-8 would reaffirm the primacy of the board of directors in corporate governance. Directors are better positioned than shareholders to make informed decisions on operational and strategic matters. Eliminating the rule would allow boards to focus on their fiduciary duties without the procedural distractions imposed by frivolous or ideological proposals.

Encouraging Efficient Governance. Without Rule 14a-8, companies could allocate resources more effectively, investing in initiatives that directly contribute to shareholder value. The elimination of costly and time-consuming proposal processes would free management to address substantive business concerns.

Aligning Corporate Governance with State Law. Corporate governance is traditionally the domain of state law, which emphasizes the contractual nature of corporate charters and bylaws. Rule 14a-8’s federal overlay disrupts this framework, imposing uniform requirements that often conflict with state-level governance principles. Repeal would restore the balance between federal and state authority in corporate governance.

Proposals for Meaningful Reform

If outright repeal is deemed impractical, significant reforms should be implemented to mitigate the flaws in Rule 14a-8.

Raising Eligibility Thresholds. The Rule currently provides that a proponent must have held “(A) At least $2,000 in market value of the company's securities entitled to vote on the proposal for at least three years; or (B) At least $15,000 in market value of the company's securities entitled to vote on the proposal for at least two years; or (C) At least $25,000 in market value of the company's securities entitled to vote on the proposal for at least one year.” These ownership thresholds are outdated and fail to ensure that proposal proponents have a meaningful economic stake in the company. Increasing the threshold to a scalable percentage of company value or a significantly higher dollar amount, such as $200,000, would deter frivolous proposals.

Lengthening Holding Periods. Requiring shareholders to hold their positions for at least three years without regard for the amount of stock they own, rather than the current tiered periods, would ensure that proposals come from long-term investors genuinely committed to the company’s success.

Narrowing the Scope of Eligible Proposals. Rule 14a-8(i)(5) should be amended to limit proposals to matters of material economic significance. The Rule currently permits a company to exclude a proposal that “relates to operations which account for less than 5 percent of the company’s total assets at the end of its most recent fiscal year, and for less than 5 percent of its net earnings and gross sales for its most recent fiscal year, and is not otherwise significantly related to the company’s business.”

Activists seized on the "not otherwise significantly related" language to argue that proposals with ethical and social significance should not be excludable even if they had no substantial economic significance. The courts and the SEC agreed. But mere ethical or social significance in the air should not be enough. Adopting a materiality standard aligned with federal securities law would prevent the inclusion of proposals addressing social or political issues unrelated to the company’s business.

The SEC should ask whether a reasonable shareholder of this issuer would regard the proposal as having material economic importance for the value of his shares. This standard is based on the well-established securities law principle of materiality. It is intended to exclude proposals made primarily for the purpose of promoting general social and political causes, while requiring inclusion of proposals a reasonable investor would believe are relevant to the value of his investment. Such a test seems desirable so as to ensure that an adopted proposal redounds to the benefit of all shareholders, not just those who share the political and social views of the proponent. Absent such a standard, the shareholder proposal rule becomes nothing less than a species of private eminent domain by which the federal government allows a small minority to appropriate someone else’s property—the company is a legal person, after all, and it is the company’s proxy statement at issue—for use as a soapbox to disseminate their views. 

Strengthening the "Ordinary Business" Exclusion. The Rule 14a-8(i)(7) exclusion allows companies to omit proposals related to ordinary business operations. Unfortunately, court and SEC decisions have largely eviscerated the ordinary business operations exclusion. Corporate decisions involving “matters which have significant policy, economic or other implications inherent in them” may not be excluded as ordinary business matters, for example, which creates a gap through which countless proposals have made it onto corporate proxy statements. As a result, the exclusion no longer fulfills its core function of preventing shareholders from micromanaging the company. The exclusion thus should be revitalized to empower boards to exclude proposals that intrude on management’s operational prerogatives.

Allowing Corporations to Opt Out. Finally, companies should be permitted to opt out of Rule 14a-8 through shareholder-approved charter amendments. This approach would respect shareholder preferences while reducing regulatory burdens.

Addressing Counterarguments

Critics of repeal or reform often argue that Rule 14a-8 is essential for holding boards accountable and providing shareholders with a voice. However, alternative mechanisms, such as direct engagement with management, annual meetings, and state-law remedies, can serve these functions without the inefficiencies associated with the current rule. Moreover, reforms like higher thresholds and longer holding periods would preserve shareholder oversight while minimizing abuse.

Conclusion

Rule 14a-8 has outlived its usefulness. Its costs, procedural inefficiencies, and susceptibility to misuse outweigh its benefits, particularly in a modern corporate governance environment where other tools for shareholder engagement exist. Repealing the rule would restore balance to corporate governance, empowering boards to focus on their fiduciary responsibilities and long-term value creation. If repeal proves politically unfeasible, meaningful reforms—such as higher ownership thresholds, stricter materiality standards, and revitalized exclusions—must be implemented to align the rule with its intended purpose.

By embracing either repeal or robust reform, policymakers can ensure that corporate governance evolves to meet the needs of modern shareholders and issuers alike.

A critique of SEC Commissioner Caroline Crenshaw's statement opposing Staff Bulletin 14M and defending the broken shareholder proposal regime

Predictably, Democratic SEC Commissioner Caroline Crenshaw opposed the important and timely SEC Staff Bulletin updating the way the SEC applies the economic significance and ordinary business exclusions to the shareholder proposal rule. I discussed the new bulletin in the prior post.

In this post, I reply to some of the claims Crenshaw makes trying to defend the indefensible.

Crenshaw repeatedly says this is a political decision: 

This type of political policy shifting mid-season serves to undercut capital formation, not facilitate it.

The rescission comes as no surprise given that the shareholder proposal process has become the target of politicized messaging ...

We are so focused on undoing the prior Commission’s agenda that we sow chaos now. 

... this leadership has rushed out staff guidance for the sake of political expediency

Elections have consequences. More important, the shareholder proposal rule has become politicized precisely because for the past several decades it has been a tool almost exclusively used by either gadflies or progressive political interest groups to advance an agenda unshared by their fellow investors. It is Crenshaw's political sponsors who have brought us to this point by turning the proposal rule into a soapbox paid for by investors at large.

True, it has finally been the case that some conservative activists are using the proposal rule to advance their agenda. (As far back as 2004, I wondered why they ignored this potential communication medium.) Not that they had much luck under Gensler.

In any case, while I acknowledge that what is sauce for the goose should also be sauce for the gander, I would prefer that no activists of any political stripe be able to abuse the rule as they have done.

Crenshaw also says that the rule has become "a  preferred punching bag of those who wish to diminish corporate democracy."

Sigh.

There is no such thing as corporate democracy. 

Just as a large city cannot be run as a New England town meeting, a large corporation is a poor candidate for direct democracy. There simply are too many widely dispersed shareholders who have varying degrees of information about the company, differing goals and investment time horizons, and competing ideas about optimal business practices for their preferences to be aggregated efficiently. Accordingly, state corporate law traditionally has given primary decision-making authority to the board and the managers to whom the board properly delegates authority. As the Delaware General Corporation Law puts it, the “business and affairs” of a corporation “shall be managed by or under the direction of a board of directors.”

Stephen M. Bainbridge, Revitalizing SEC Rule 14a-8's Ordinary Business Exclusion: Preventing Shareholder Micromanagement by Proposal, 85 Fordham L. Rev. 705, 707–08 (2016). Put simply, democracy is not an appropriate metaphor for corporate governance. It thus cannot serve as a justification for the shareholder proposal rule.

Finally, Crenshaw complains that the new bulletin will allow exclusion of "topics relating to poison pills, compensation, emerging issues such as AI, political and lobbying expenditures, and environmental or other issues that shareholders have identified as materially impacting the firm’s financial value." (My emphasis.)

I call BS. These are not topics that investors have identified as materially impacting the firm’s financial value.

How do I know? Because proposals advanced by leftwing activists relating to those proposals almost always fail to receive majority support. In a 2003 Barrons op-ed, for example, I wrote that:

Recent SEC guidance allowing more proposals dealing with broad societal issues to be considered has led to a significant increase in the number of shareholder proposals centered on political questions. But while the SEC insists that investors are demanding these changes, shareholders are increasingly rejecting proposals dealing with social issues. In fact, in 2023, support for ESG-related proposals fell to just 22% on average, a decline of 11 percentage points since 2021.

ExxonMobil, Chevron, JP Morgan, and Goldman Sachs all defeated proposals that would require the companies to disclose their absolute emissions data rather than carbon intensity metrics, Bloomberg Law recently reported. ...

As I explained in my recent book, The Profit Motive, most investors still care mainly about maximizing value rather than advancing partisan agendas.

In thinking about Crenshaw's statement I couldn't help but recall a Friends episode in which Russ told Ross "You could not be more wrong. You could try but you would not be successful."

Acting SEC Chair puts long needed limits on shareholder activism via proposals

Last week the SEC issued Staff Legal Bulletin No. 14M. It makes some key changes in how the SEC will apply the shareholder proposal rule during the current proxy season.

In brief, the shareholder proposal rule (SEC Rule 14a-8) allows shareholders to submit proposals for inclusion in company proxy materials, provided the proposals are proper subjects for shareholder action under state law.

Initially envisioned as a mechanism to enhance shareholder participation, Rule 14a-8 has instead evolved into a tool for a minority of activists to advance agendas often unrelated to the company’s financial performance. This evolution has come at a cost: growing procedural complexity, increased compliance burdens, and the diversion of board attention from strategic priorities.

Rule 14a-8 is disproportionately utilized by a handful of "corporate gadflies," who submit proposals on personal, political, or social issues rather than matters of economic importance to the company. For instance, data indicate that a mere three individuals or groups account for a substantial portion of shareholder proposals submitted annually.

Moreover, union pension funds and other institutional investors often leverage the rule to advance private agendas, such as labor disputes or political initiatives, rather than promoting shareholder value. These practices deviate from the rule's intended purpose and impose additional costs on the majority of shareholders.

Rule 14a-8 also undermines board primacy by forcing directors to engage with proposals that delve into operational matters traditionally reserved for management. This distraction erodes the business judgment rule's protections and detracts from boards' focus on long-term value creation.

There are a number of grounds on which management can refuse to include a proposal. Two are particularly significant at the moment.

The first is the exclusion for proposals lacking economic significance. It permits a company to exclude a proposal that “relates to operations which account for less than 5 percent of the company’s total assets at the end of its most recent fiscal year, and for less than 5 percent of its net earnings and gross sales for its most recent fiscal year, and is not otherwise significantly related to the company’s business.”

Activists seized on the "not otherwise significantly related" language to argue that proposals with ethical and social significance should not be excludable even if they had no substantial economic significance. The courts and the SEC under liberal administrations agreed. In recent years, under the execrable Gary Gensler, progressive proposals lacking any meaningful nexus to the company's business have been waved through by the SEC.

Not anymore:

The Division’s analysis will focus on a proposal’s significance to the company’s business when it otherwise relates to operations that account for less than 5% of total assets, net earnings and gross sales. Under this framework, proposals that raise issues of social or ethical significance may be excludable, notwithstanding their importance in the abstract, based on the application and analysis of each of the factors of Rule 14a-8(i)(5) in determining the proposal’s relevance to the company’s business.

Because the rule allows exclusion only when the matter is not “otherwise significantly related to the company,” we view the analysis as dependent upon the particular circumstances of the company to which the proposal is submitted. That is, a matter significant to one company may not be significant to another.  ...

... The proponent could continue to raise social or ethical issues in its arguments, but in accordance with these Commission statements it would need to tie those matters to a significant effect on the company’s business. The mere possibility of reputational or economic harm alone will not demonstrate that a proposal is “otherwise significantly related to the company’s business.” 

I suggest that in applying this standard that the SEC should ask whether a reasonable shareholder of this issuer would regard the proposal as having material economic importance for the value of his shares. This standard is based on the well-established securities law principle of materiality. It is intended to exclude proposals made primarily for the purpose of promoting general social and political causes, while requiring inclusion of proposals a reasonable investor would believe are relevant to the value of his investment. Such a test seems desirable so as to ensure that an adopted proposal redounds to the benefit of all shareholders, not just those who share the political and social views of the proponent. Absent such a standard, the shareholder proposal rule becomes nothing less than a species of private eminent domain by which the federal government allows a small minority to appropriate someone else’s property—the company is a legal person, after all, and it is the company’s proxy statement at issue—for use as a soapbox to disseminate their views. 

The other is where the proposal speaks to the ordinary business of the company (Rule 14a-8(i)(7)).

As I explained in my article, Revitalizing SEC Rule 14a-8's Ordinary Business Exemption: Preventing Shareholder Micromanagement by Proposal, Rule 14a-8(i)(7) raises fundamental issues of corporate governance:

Who decides what products a company should sell, what prices it should charge, and so on? Is it the board of directors, the top management team, or the shareholders? In large corporations, of course, the answer is the top management team operating under the supervision of the board. As for the shareholders, they traditionally have had no role in these sort of operational decisions. In recent years, however, shareholders have increasingly used SEC Exchange Act Rule 14a-8 (the so-called shareholder proposal rule), to not just manage but even micromanage corporate decisions.

The rule permits a qualifying shareholder of a public corporation registered with the SEC to force the company to include a resolution and supporting statement in the company’s proxy materials for its annual meeting. In theory, Rule 14a-8 contains limits on shareholder micro-management. The rule permits management to exclude proposals on a number of both technical and substantive bases, of which the exclusion in Rule 14a-8(i)(7) of proposals relating to ordinary business operations is the most pertinent for present purposes. Rule 14a-8(i)(7) is intended to permit exclusion of a proposal that “seeks to ‘micro-manage’ the company by probing too deeply into matters of a complex nature upon which shareholders, as a group, would not be in a position to make an informed judgment.”

Unfortunately, court decisions have largely eviscerated the ordinary business operations exclusion. Corporate decisions involving “matters which have significant policy, economic or other implications inherent in them” may not be excluded as ordinary business matters, for example, which creates a gap through which countless proposals have made it onto corporate proxy statements.

In effect, the exclusion no longer fulfills its core function of preventing shareholders from micromanaging the company.

The new staff bulletin goes at least part of the way towards giving the exclusion teeth.

... the staff will take a company-specific approach in evaluating significance, rather than focusing solely on whether a proposal raises a policy issue with broad societal impact or whether particular issues or categories of issues are universally “significant.” Accordingly, a policy issue that is significant to one company may not be significant to another. The Division’s analysis will focus on whether the proposal deals with a matter relating to an individual company’s ordinary business operations or raises a policy issue that transcends the individual company’s ordinary business operations.

The new staff bulletin also reinstates two Trump 1.0 era staff bulletins on the exclusion that Gensler gutted. Both speak to the micromanagement issue. Bulletin 14J stated:

... a proposal may probe too deeply into matters of a complex nature if it “involves intricate detail, or seeks to impose specific time-frames or methods for implementing complex policies.”

A proposal thus can be excluded if it:

“micromanages” the company “by probing too deeply into matters of a complex nature upon which shareholders, as a group, would not be in a position to make an informed judgment.”

Importantly, the bulletin made clear that a standard activist technique to end run the exclusion would no longer work:

This framework also applies to proposals that call for a study or report. For example, a proposal that seeks an intricately detailed study or report may be excluded on micromanagement grounds.

Bulletin 14K provided that:

In the past, proponents and companies have often focused on the overall significance of the policy issue raised by the proposal, instead of whether the proposal raises a policy issue that transcends the particular company’s ordinary business operations. The staff takes a company-specific approach in evaluating significance, rather than recognizing particular issues or categories of issues as universally “significant.” Accordingly, a policy issue that is significant to one company may not be significant to another.

... we believe the focus of an argument for exclusion under Rule 14a-8(i)(7) should be on whether the proposal deals with a matter relating to that company’s ordinary business operations or raises a policy issue that transcends that company’s ordinary business operations. When a proposal raises a policy issue that appears to be significant, a company’s no-action request should focus on the significance of the issue to that company.

In sum, the new bulletin is a good start. It addresses some key problem areas that have allowed activist shareholders to use the rule to advance social proposals largely unrelated to the business of the company.

More needs to be done. But that is a story for another post.

Corporate Directors Can't Change the Rules in the Middle of the Game

Ann Lipton reports on an interetsing new case:

Daktronics is incorporated in South Dakota of all places (is it lonely there?).  South Dakota mandates cumulative voting, which makes it much, much easier for a minority blockholder to gain board representation, as Matt Levine explains here.

And such a blockholder has emerged, in the form of Alta Fox.  Alta Fox is both a shareholder and a holder of Daktronics notes, but the notes are convertible into shares, so on a fully diluted basis, Alta Fox owns over 11% of Daktronics’ voting power.  Given that, at least some of Alta Fox’s director nominees would likely have been seated in a proxy contest but – plot twist! – Daktronics called a special meeting of its shareholders to vote on reincorporation to Delaware, where cumulative voting is not the default.

And, as I understand it, Daktronics is calling for that vote before Alta Fox’s shares convert, so that Alta Fox will be heading into the meeting with less than its full voting power. In response, Alta Fox filed a lawsuit (in federal court, presumably because it just likes the judges and/or procedures better), alleging that Daktronics’s proposal represents a breach of fiduciary duty and shareholder oppression.

Ann points out that the reincorporation "is intended to thwart shareholder voting rights in the context of a particular, threatened proxy contest."

Like Ann, I don't know what specific South Dakota law says, but general corporate law principles says you can't change the rules of the game in the middle of an election contest. From my book Corporate Law:

This effect is nicely illustrated by Coalition to Advocate Public Utility Responsibility, Inc. v. Engels.[1] Northern States Power Company (NSP) had 14 directors, each elected annually for a one-year term by means of cumulative voting. In 1973, CAPUR (a coalition of consumer and environmental groups) sought to elect to the board a “public interest” candidate named Alpha Smaby (really).[2] Smaby promised that, if elected to the board, she would promote the ‘‘public interest” with special concern for environmental and consumer issues. NSP’s board opposed Smaby’s election and sought to prevent it by (1) reducing the number of directors to 12 and (2) classifying the board into three groups of four directors with staggered three-year terms. As a result, only four directors would be up for election in any given year. Under the old rules, Smaby needed the cumulated votes of just over 7% of the shares to be elected. The changes made by the board raised the number of shares needed to assure her election to about 20%.

Both changes were permitted by statute. Most corporate law codes give the board power to make unilateral changes in its size. Most likewise permit the corporation to have a staggered board. The trial court nonetheless granted a preliminary injunction against the board. Why? Because it is inequitable to change the rules in the middle of the game—or so the court opined. Consistent with well-established principles of Delaware law,[3] the court held that otherwise lawful actions can be enjoined as if they unfairly injure rights of minority shareholders. By implementing these changes in the middle of an election campaign, without disclosure, and for the purpose of defeating a minority candidate, the board breached its fiduciary duties. Although the election thus went forward under the old rules, Smaby ultimately did not receive a sufficient number of votes to be elected.[4] The case nevertheless reaffirms the principle that otherwise lawful board action becomes impermissible if undertaken in the midst of an election campaign for the purpose of obstructing a legitimate effort by dissident shareholders to obtain board representation. From the perspective of corporate counsel working with the incumbent directors, of course, the transactional implication is that such changes should be undertaken in mid-year long before any insurgent shareholders begin making noise.

Corporate Directors Can't Change the Rules in the Middle of the Game

Ann Lipton reports on an interetsing new case:

Daktronics is incorporated in South Dakota of all places (is it lonely there?).  South Dakota mandates cumulative voting, which makes it much, much easier for a minority blockholder to gain board representation, as Matt Levine explains here.

And such a blockholder has emerged, in the form of Alta Fox.  Alta Fox is both a shareholder and a holder of Daktronics notes, but the notes are convertible into shares, so on a fully diluted basis, Alta Fox owns over 11% of Daktronics’ voting power.  Given that, at least some of Alta Fox’s director nominees would likely have been seated in a proxy contest but – plot twist! – Daktronics called a special meeting of its shareholders to vote on reincorporation to Delaware, where cumulative voting is not the default.

And, as I understand it, Daktronics is calling for that vote before Alta Fox’s shares convert, so that Alta Fox will be heading into the meeting with less than its full voting power. In response, Alta Fox filed a lawsuit (in federal court, presumably because it just likes the judges and/or procedures better), alleging that Daktronics’s proposal represents a breach of fiduciary duty and shareholder oppression.

Ann points out that the reincorporation "is intended to thwart shareholder voting rights in the context of a particular, threatened proxy contest."

Like Ann, I don't know what specific South Dakota law says, but general corporate law principles says you can't change the rules of the game in the middle of an election contest. From my book Corporate Law:

This effect is nicely illustrated by Coalition to Advocate Public Utility Responsibility, Inc. v. Engels.[1] Northern States Power Company (NSP) had 14 directors, each elected annually for a one-year term by means of cumulative voting. In 1973, CAPUR (a coalition of consumer and environmental groups) sought to elect to the board a “public interest” candidate named Alpha Smaby (really).[2] Smaby promised that, if elected to the board, she would promote the ‘‘public interest” with special concern for environmental and consumer issues. NSP’s board opposed Smaby’s election and sought to prevent it by (1) reducing the number of directors to 12 and (2) classifying the board into three groups of four directors with staggered three-year terms. As a result, only four directors would be up for election in any given year. Under the old rules, Smaby needed the cumulated votes of just over 7% of the shares to be elected. The changes made by the board raised the number of shares needed to assure her election to about 20%.

Both changes were permitted by statute. Most corporate law codes give the board power to make unilateral changes in its size. Most likewise permit the corporation to have a staggered board. The trial court nonetheless granted a preliminary injunction against the board. Why? Because it is inequitable to change the rules in the middle of the game—or so the court opined. Consistent with well-established principles of Delaware law,[3] the court held that otherwise lawful actions can be enjoined as if they unfairly injure rights of minority shareholders. By implementing these changes in the middle of an election campaign, without disclosure, and for the purpose of defeating a minority candidate, the board breached its fiduciary duties. Although the election thus went forward under the old rules, Smaby ultimately did not receive a sufficient number of votes to be elected.[4] The case nevertheless reaffirms the principle that otherwise lawful board action becomes impermissible if undertaken in the midst of an election campaign for the purpose of obstructing a legitimate effort by dissident shareholders to obtain board representation. From the perspective of corporate counsel working with the incumbent directors, of course, the transactional implication is that such changes should be undertaken in mid-year long before any insurgent shareholders begin making noise.