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An Academic Perspective on Shareholder Activism as a Corrective Mechanism

The editors at the Corporate Governance & Social Responsibility blog brought our attention to a recent academic paper from The Ohio State University Moritz College of Law titled “Shareholder Activism as a Corrective Mechanism in Corporate Governance.” In the paper’s abstract, authors Paul Rose and Bernard Sharfman write:

Under an Arrowian framework, centralized authority and management provides for optimal decision making in large organizations. However, Arrow also recognized that other elements within the organization, outside the central authority, occasionally may have superior information or decision making skills. In such cases, such elements may act as a corrective mechanism within the organization. In the context of public companies, this article finds that such a corrective mechanism comes in the form of hedge fund activism, or more accurately, offensive shareholder activism.

Offensive shareholder activism exists in the market for corporate influence, not control. Consistent with a theoretical framework where the value of centralized authority must be protected and a legal framework in which fiduciary responsibility rests with the board, authority is not shifted to influential but unaccountable shareholders. Governance entrepreneurs in the market for corporate influence must first identify those instances in which authority-sharing may result in value-enhancing policy decisions, and then persuade the board and/or other shareholders of the wisdom of their policies so that they will be permitted to share the authority necessary for the policies to be implemented. Thus, boards often reward offensive shareholder activists that prove to have superior information and/or strategies by at least temporarily sharing authority …

Shareholder Approval of Equity Incentive Plan; Has It Been Five Years?

Most equity incentive plans have a number of different shareholder-approved business criteria for setting performance goals and allow the compensation committee to select the criteria each year. This practice generally requires re-approval of the goals by the shareholders under Internal Revenue Code Section 162(m) whenever the committee makes a material change to the criteria. If the committee has not made any material changes to the performance criteria but retains discretion to select the performance targets from year-to-year, shareholders generally will need to reapprove the criteria every five years under Code Section 162(m).

If shareholder approval last occurred in 2009, then it is time to prepare for re-approval in 2014. This is also a good time to consider if an amendment is needed to increase the authorized share pool.…

Lessons From In re Trados: Delaware Courts Skeptical of Independence of Directors of Portfolio Companies

In our previous posts about In re Trados available here and here, we provided some background about the facts, outcome and usefulness of the Trados case, as well as a discussion of the conflicting interests of the preferred stockholders and common stockholders. In this installment, we will discuss the issue of director independence and conflicts of interest of the Trados directors, and the related analysis conducted by the Delaware Court of Chancery.

In determining whether directors have met their fiduciary duties, the standard of review used by the court is critical to the inquiry. The entire fairness standard, Delaware’s most onerous standard, applies when the directors have actual conflicts of interest.1 To obtain review under the entire fairness standard, a plaintiff must prove that a majority of the directors making the challenged decision were not independent and disinterested.2 In Trados, the plaintiff successfully proved that six of the seven Trados directors were not disinterested and independent, making entire fairness the operative standard of review.3

A thorough discussion of the court’s director by director analysis in Trados illustrates the Delaware courts’ willingness to find that directors of venture capital and private equity portfolio companies are conflicted, thereby triggering an entire fairness review.…

So Where to Next for Corporate Governance?

This post appeared originally on the Corporate Governance & Social Responsibility blog. The Federal Securities Law Blog thanks the author for allowing us to share it with you.

It was a pretty normal day until Marc Smith called me for a chat on Skype. Marc is a sociologist of computer-mediated collective action at Connected Action and director at Social Media Research Foundation, Belmont, CA, and in 90 minutes he just confirmed everything I thought about the development and future of the Internet and social networks. We discussed Twitter networks predominantly, but the model transfers to any networked entity where one named thing interacts with (talks to) another. Stay with me on this…

Social networks are, after all and as I figured, extrapolated scaled models of our intrinsic human social permutations and permeations, perhaps even our psyche (doffing my hat to Freud and Jung). They even start from archetypes (Jung, again), they develop organically, and they form structures that reflect our ‘collective’ [Jung would have said ‘collective unconscious’, probably]. Bizarrely, that thin veneer of perceived protection from recourse for our actions afforded by thinking “well, its only a tweet” might even strip away some of the social airs and graces we might have in our fleshy lives, leaving a more immediate expression of our underlying thoughts, maybe, in some cases, perhaps.…

Lessons from In re Trados: Conflicting Interests of Preferred and Common Stockholders

In our previous post about In re Trados, we provided some background on the facts, outcome and usefulness of the Trados case. In this installment, we will discuss the conflict of interest between the preferred stockholders and the common stockholders of Trados and the related analysis conducted by the Delaware Court of Chancery.

Divergence in Interests of Preferred and Common Stockholders

Due to the liquidation preference of preferred stock, preferred stockholders and common stockholders can have diverging interests in exit transactions. “Because of the preferred shareholders’ liquidation preferences, they sometimes gain less from increases in firm value than they lose from decreases in firm value. This effect may cause a board dominated by preferred shareholders to choose lower-risk, lower-value investment strategies over higher-risk, higher-value investment strategies.1…

Fiduciary Duties in M&A Exit Transactions: Lessons from In re Trados

On Aug. 16, 2013, the Delaware Court of Chancery issued an opinion1 finding that the directors of TRADOS Inc. (Trados) did not breach their fiduciary duties in deciding to sell Trados despite the common stockholders receiving no sale consideration; (ii) a majority of the directors approving the transaction having a conflict of interest; (iii) the court’s review under the entire fairness standard; and (iv) the directors’ failure to follow a fair process, because the common stockholders received a fair price (i.e. the value of the common stock immediately prior to the merger was zero and the common stockholders received zero in the merger).

Though In re Trados is not groundbreaking in the sense that it does not present any novel legal issues, it nonetheless serves as an important illustration of common conflict of interest and fiduciary duty issues that arise in a typical exit transaction fact pattern, particularly for venture capital or private equity backed companies. Through the next several weeks, we will discuss in more detail some of the important takeaways from In re Trados in a series of blog posts.…

Are You Sure You’re S-3 Eligible? A Reminder to Disclose the Board’s Decision Regarding Frequency of Say-on-Pay Vote on Form 8-K

Though most reporting companies conducted their first say-on-pay vote in 2011 and disclosed the shareholder voting results on Form 8-K, some companies overlooked the additional requirement to disclose the board of directors’ decision (in light of the shareholders’ advisory vote) regarding the frequency that the company will conduct say-on-pay votes. A company’s failure to file this Form 8-K regarding the board’s decision on the say-on-pay vote frequency could result in the company being an untimely filer and ineligible to use Form S-3. Fortunately, the SEC staff indicated in its 2012 “SEC Speaks” conference that it will likely grant waivers to companies if:

  1. they file an amended Form 8-K indicating the board’s decision on the say-on-pay vote frequency; and
  2. the board’s decision on say-on-pay vote frequency followed the shareholder’s recommendation.

However, anecdotal conversations with the SEC staff have indicated that:

  • waivers are not always granted;
  • the board’s decision on say-on-pay vote frequency must match the board’s recommendation in addition to matching the shareholder’s recommendation for a waiver to be granted; and
  • the SEC does not intend to grant waivers forever.

Icahn Re: Apple: Shareholder Activism or Stock Manipulation?

At 2:21 p.m. and at 2:25 p.m., on August 13, 2013, Carl Icahn issued the following tweets:

carl icahn

Shortly after sending that tweet, Apple shares jumped on the news closing 4.8% higher for the day, increasing Apple’s market cap by almost $17.1 billion.

Mr. Icahn’s tweets have been viewed as shareholder activism. Not many individuals have the power to move markets in the same way that Mr. Icahn was able to do with Apple. Could these types of actions really be viewed as market manipulation rather than shareholder activism? Should the Securities and Exchange Commission put rules and restrictions on such communications for these type of high profile individuals? Fodder for an interesting debate.

 

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District Court Vacates Resource Extraction Issuer Payment Disclosure Rules; May Foreshadow Ruling on Conflict Minerals Challenge

On July 2, 2013, the United States District Court for the District of Columbia (the “Court”) vacated Securities and Exchange Commission (“SEC”) Rule 13q-1 (the “Rule”), which required certain companies to disclose payments made to foreign governments in connection with the commercial development of oil, natural gas or minerals. The Court found that (i) the SEC erroneously read the statutory language as requiring public disclosure of these payments; and (ii) that the SEC’s decision to deny any exemption to the disclosure requirements, specifically in the case of countries that prohibit disclosure of these payments, was arbitrary and capricious.…

Government’s Vigorous Prosecution of FCPA Violators Continues When Jury Convicts Two Telecommunications Executives for Violations Relating to Haiti

On Friday, August 5, 2011, a Florida jury convicted Joel Esquenazi and Carlos Rodriguez, former executives of Terra Telecommunications Corporation, for their roles in a conspiracy to violate the FCPA and commit money laundering. U.S. v. Esquenazi, Case No. 09-cr-21010 (S.D. Fla. Filed Dec. 4, 2009), The convictions were the latest event in Government’s aggressive prosecution of FCPA violations for bribes paid to Telecommunications D’Haiti S.A.M. ("Haiti Teleco"), a state-owned telecommunications company in Haiti.…

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