A Few Observations on Shareholders in 2015

Chair Mary Jo White

Tulane University Law School 27th Annual Corporate Law Institute
New Orleans, Louisiana

March 19, 2015

Introduction

Thank you, Faiza [Saeed], for that kind introduction. I am honored to be here at Tulane´s 27th Annual Corporate Law Institute. As usual, you have gathered an incredibly distinguished group to discuss cutting-edge issues in M&A.

Today, I will share a few observations on three specific areas: the current state of shareholder activism; the shareholder proposal process; and fee-shifting bylaws. I know your next two panels take up aspects of these important topics, but I think the space is lively and big enough for all of us to comment.

The Current Activism Landscape

There are different views on what is meant by "shareholder activism," but just the word "activism" triggers an adverse reaction from many companies. Reflexively painting all activism negatively is, in my view, using too broad a brush and indeed is counterproductive. To me, the term activism captures the range of efforts by investors to influence a company´s management or decision-making. Some of it is constructive. In certain situations, activism seeks to bring about important changes at companies that can increase shareholder value. Now, some of you may find the juxtaposition of the word "activism" with "shareholder value" does not comport with your sense of reality. Some of you also believe that activists are not interested in increasing long-term value for shareholders and other stakeholders. Still others will assert that activists are simply short-term traders looking to make a quick dollar. I did say this was a lively topic with many different views.

Activism is used to achieve a variety of outcomes: board seats or control of the board; an acquisition or spin-off of a non-core or unprofitable line of business; or a share buyback. Negotiations between an activist and a target company may take place privately, or an activist may choose to go public. An activist may also begin a campaign behind the scenes, but go public if it believes it is not being heard or making enough progress. Any of these approaches, if used in the right circumstances, can be compatible with the kind of engagement that I hope companies and shareholders can foster.

Increasingly, companies are talking to their shareholders, including so-called activist ones.[1] That, in my view, is generally a very good thing. Increased engagement is important and a growing necessity for many companies today.

The activism landscape in 2015 continues to evolve. While activists traditionally focused on small and significantly underperforming companies, many of them today are also targeting larger issuers that are not necessarily poor performers. [2] Campaigns also appear to be experiencing greater success. Activist investors secured at least one board seat in roughly 73% of all proxy fights in 2014, up from the previous year´s record of 63%.[3] And the campaign objectives appear to be shifting, with breakups, a review of strategic alternatives, and corporate control transactions featuring more prominently, and governance issues arising less frequently.[4]

Hedge funds are playing a much more prominent role in this space and their size and influence are growing; interesting, new players are joining their ranks. The total assets under management for such funds has been pegged at more than $120 billion in 2015 — a roughly 30% jump from 2014.^[5] Their growing presence has undeniably changed the corporate landscape. But is that good or bad, or both?

As you know, an intense debate is taking place in the business, legal and academic communities as to whether activism by hedge funds and others is a positive or negative force for U.S. companies and the economy. Some believe that activism of all stripes is essential to effect necessary management and board changes at underperforming companies,[6] while others contend that certain activism results in short-term gains at the expense of companies and shareholder value in the long run.[7] Competing economic studies have helped fuel the debate by asserting that activism leads to either increased or decreased long-term economic well-being for targeted companies. One study, for example, found that activist campaigns are followed by improved operating performance during the five-year period after the campaign,[8] while another study observed that activists´ impact on operating performance is, at best, "very unclear."[9]

It is an interesting and important debate, but our role at the SEC is not to determine whether activist campaigns are beneficial or detrimental in any given circumstance. Rather, the agency´s central focus is making sure that shareholders are provided with the information they need and that all play by the rules.

Our staff in the Division of Corporation Finance typically gets involved once an activist campaign becomes public, be it by way of a proxy fight or other non-routine proxy solicitation, a tender offer, or pertinent disclosure in an investor´s beneficial ownership reports. The staff reviews materials related to these campaigns to facilitate compliance with the applicable disclosure requirements so that shareholders receive the information necessary to make an informed investment or voting decision. No matter how contentious the relationship is between the activist and the company, or how high the stakes, all parties, including activists and management, are obligated under the federal securities laws to provide shareholders with timely, clear, complete and accurate disclosures about the subject matter and their interests.[10]

All parties should make their obligations under the federal securities laws a high priority. For example, parties should be mindful of the requirements under Regulation 13D-G to file their initial and amended beneficial ownership reports on a timely basis, and provide accurate and complete disclosure about their plans or proposals, rather than recite boilerplate that obfuscates their true intentions or their coordination with other investors. The concern about inaccurate and incomplete beneficial ownership reports is not theoretical. Just last week, we brought actions against eight individuals and entities — including officers, directors and major shareholders — for failing to update their 13Ds to reflect material changes, including a series of significant steps to take the companies private. [11]

Activists and companies should also pay special attention to Exchange Act Rule 14a-9 — the prohibition against making material false and misleading statements or omissions in proxy solicitations — as they make their cases for or against change in their fight letters and other communications under the federal proxy rules. While I appreciate the importance of allowing the parties to fully debate the issues in what may be adversarial situations, they should be careful not to make claims or accuse others of wrongdoing without an adequate factual foundation.

While I am on the topic of disclosure, it was implicated in an interesting way in a recent takeover bid this past year — a bid with which you are likely familiar. In that bid, we saw a unique pairing of a strategic bidder and an activist hedge fund in which the parties took novel and, for some, controversial steps that generated significant interest. Initially, the hedge fund publicly sought to call an informal meeting of the target company´s shareholders and filed a proxy statement with the Commission for a solicitation in connection with such a meeting, which it referred to as a "shareholder referendum" — a mechanism not provided for in the company´s bylaws. The objective was to seek shareholder support in favor of a non-binding resolution to request that the target´s board promptly engage in good faith negotiations about an acquisition of the company.

Some questioned whether a shareholder has the ability to call a meeting of shareholders outside of a company´s bylaw framework, hold a non-binding vote by way of a proxy solicitation, and file a purported proxy statement under the proxy rules. Specific questions were raised about whether communications relating to such a shareholder referendum should be allowed to be filed as soliciting materials under the Commission´s proxy rules. The concern was that doing so could give the disputed materials a form of official imprimatur. All fair questions.

SEC rules do not specifically address shareholder referendums. And it is state law and a company´s corporate instruments that provide the rules for shareholder meetings and specify what are proper matters for shareholder action. Whether a shareholder referendum is a form of proper corporate action under state law is thus a question best left to state legislatures and the courts. For our part, the Commission has long taken steps to facilitate shareholders communicating with one another.[12] Our federal proxy rules, which quite broadly define the term "solicitation," provide procedural protections that support the exercise of voting rights granted under state law.[13]

To fully effectuate that objective, the staff has a longstanding practice of accepting and looking at all filings, even if it is unclear whether the filing was required under our rules as a "solicitation." Whenever a filing is made, we expect it to fully comply with the applicable disclosure requirements, and filers assume potential liability under the federal securities laws. The staff´s goal in such a situation is to ensure that the filing complies with the applicable rules and that shareholders are provided with complete and accurate material information. The alternative in this context would be for the referendum to go forward under the radar, without public disclosure, without SEC staff oversight, and without the protection of our rules.

Ultimately, the shareholder referendum I mentioned was abandoned and the hedge fund called a special meeting of the target company´s shareholders pursuant to the company´s bylaws. We do not know whether other activist shareholders will try the shareholder referendum approach in future campaigns. If they do, you can expect the SEC staff to perform its oversight role of ensuring that investors receive timely, complete and accurate disclosure.

Even though the SEC staff does not act as a "merits or behavior referee," parties should still take a hard look at their actions and rhetoric and consider whether they are engaged in a constructive dialogue and facilitating a constructive resolution. I recognize, of course, that highly sophisticated strategies have come to dominate proxy fights and takeover bids; I have been involved in them as a private sector lawyer. And it is not my intent to threaten the vibrancy of anyone´s practice area. But I do think it is time to step away from gamesmanship and inflammatory rhetoric that can harm companies and shareholders alike. Fortunately, by some accounts, companies and activists are starting to make positive progress,[14] as they increasingly engage with each other and negotiate outcomes that seem more mutually beneficial.

* * *

Rule 14a-8 Shareholder Proposals

Shareholders obviously do not have to resort to a proxy contest to engage with companies. They can and often do engage through the SEC shareholder proposal process.

Exchange Act Rule 14a-8 enables shareholders meeting certain requirements to have their proposal included in a company´s proxy materials. And shareholders often take advantage of this option. By one count, over 400 shareholder proposals were voted on at U.S. companies in 2014.[15] The total number of shareholder proposals submitted to companies was undoubtedly much higher as this tally does not reflect the proposals that may have been submitted and withdrawn as a result of negotiations between companies and their shareholders, or that may have been excluded under our shareholder proposal rule.

This proxy season, there has been special interest in the shareholder proposal and staff no-action process. I played a role in that.

The initial event that sparked interest was the staff´s decision in December on a no-action request by a company to exclude from its proxy materials, under Rule 14a-8(i)(9), a shareholder proposal seeking proxy access, on the grounds that it directly conflicted with a proposal subsequently made by the company.[16] Many other companies have received similar shareholder proposals, and, after the initial no-action letter was granted, they made similar arguments in seeking no-action letters from the staff to exclude the proposals.[17]

One shareholder proponent raised questions about the proper application of our rules and sought reconsideration of the staff´s initial decision to issue a no-action letter. Others raised questions as well.[18] After reviewing the proposals, counterproposals and competing arguments, I was not comfortable that I or the staff had sufficient opportunity to consider the questions and concerns that were raised about how to interpret the term "directly conflicts" under Rule 14a-8 in the particular context presented. So, I requested that the staff review the appropriate application of the provision and report to the Commission on its findings.[19] In light of the pending review, the Division of Corporation Finance decided not to express a view on the provision during the current proxy season.[20]

The staff´s review is ongoing, and it would not be appropriate to talk about the specifics of the proposal or staff responses. But I would like to make a few comments about our shareholder proposal rule and the no-action process generally.

Every year, the staff receives approximately 300-400 requests to exclude shareholder proposals under Rule 14a-8. A team of staff members reviews these requests and provides a response to assist both companies and shareholders in complying with the rule. While the staff strives for consistency and correctness in the administration of this process, their informal responses are neither "precedent" nor binding on the Commission or a court. And, over time, views and interpretations may evolve, and changes may be reflected in guidance, interpretation, or rule changes if necessary.[21]

While the staff works tirelessly to review and respond to all requests consistently and in a timely manner, they have the discretion to decline to review requests for no-action letters. It is, and should be, rare for the staff to decline to review a request, but it does happen, as it did this proxy season.[22]

There has been considerable discussion — and some not insignificant consternation — about my direction to the staff to examine the application of Rule 14a-8(i)(9) and the staff´s subsequent decision to decline this season to review requests asserting that rule as a basis for exclusion. I recognize that my direction and the staff´s decision has raised new questions and resulted in a change in how some companies were expecting to address some shareholder proposals this season. While any frustrated expectations are regrettable, my request was driven by a deeper concern that the application of (i)(9), as originally interpreted by the staff, could result in unintended consequences and potential misuse of our process. The purpose of the review is to think carefully about the application of the rule and a variety of related questions.

Keith Higgins, our Director of the Division of Corporation Finance, recently discussed a number of these questions.[23] By way of example, if a management proposal is made in response to a shareholder proposal on the same subject matter, does that end the inquiry — and the company may exclude the shareholder proposal because it "directly conflicts" with management´s proposal? What if the proposals have the same subject matter, but the terms differ? What if management´s proposal could be viewed as a proposal that, if adopted, may purport to provide shareholders with the ability to do something, such as call a special meeting or include a nominee for director in a company´s proxy materials, but that, in fact, no shareholder would be able to meet the criteria to do so? If a company excludes a shareholder proposal because it conflicts with the company´s own proposal on the same subject matter, should the company have to disclose to its shareholders the existence of the shareholder proposal? What if the company´s competing proposal was offered only in response to the shareholder´s proposal — should the company have to disclose its motivations for its own proposal? I am looking forward to the results of the staff´s review on these and other questions.

In impartially administering the rule, we must always consider whether our response would produce an unintended or unfair result. Gamesmanship has no place in the process.

* * *

Fee-Shifting Bylaws

Changing focus a bit, I would like to briefly mention one more issue that appears to be getting some initial traction in the issuer community — fee-shifting bylaws. A great deal of debate has taken place about bylaw and charter provisions that shift the company´s costs in shareholder litigation to the plaintiff shareholder if the shareholder loses or is not entirely successful on all claims.

Just for context, the so-called "American rule" is that each party in litigation generally bears its own costs.[24] In shareholder derivative actions, however, courts can require that a company pay the attorneys´ fees of a successful shareholder out of the proceeds of any judgment or settlement.[25] This is designed to incentivize a shareholder to bring suit where the costs could be high and the individual return may be small but shareholders as a whole could benefit.[26] Under the federal securities laws, Section 11(e) of the Securities Act also allows, in the court´s discretion, the imposition of costs and attorneys´ fees against either party whose suit or defense is found to have been without merit, including in class actions.[27]

In May 2014, the Delaware Supreme Court ruled that a fee-shifting provision in a bylaw could be valid under Delaware law,[28] although it left open the questions of whether the manner in which the provision was adopted or the circumstances under which it would be invoked could make the bylaw unenforceable. Thereafter, more than 40 companies[29] adopted some form of similar fee-shifting provisions. Concerns have been expressed that such bylaws could stifle shareholder actions against companies because the provisions are one-sided and only apply to shareholders who lose, including, in some situations, those who lose any part of their claim. Recently, the Delaware Corporation Law Council[30] recommended that the Delaware General Corporation Law be amended to expressly prohibit companies from including fee-shifting bylaws for claims brought against officers and directors for violation of their state law duties, but no action has been taken to date.

There have been calls for the Commission to intervene in some way, including possibly participating by way of an amicus brief in an appropriate case to advance possible pre-emption and/or public policy arguments. [31] While I am not commenting today on such calls or the merits of any particular argument, I will say that the SEC and courts have long recognized that the ability of shareholders to bring an action under the federal securities laws provides them with an important remedy that can complement our enforcement actions.[32]

Our staff is thus keeping a very close eye on the evolving developments, and I am too. Specifically, our staff is focused on making sure the disclosures in company filings about its fee shifting provision — and the implications of such provisions — are clear. If a company chooses to adopt a fee-shifting provision, it should clearly communicate to shareholders the specific features of the provisions and its effect on shareholders´ ability to bring a claim. Shareholders should be fully informed of a company´s efforts to affect their ability to seek redress so that the issue can be considered in voting and investment decisions.

I am concerned about any provision in the bylaws of a company that could inappropriately stifle shareholders´ ability to seek redress under the federal securities laws. All shareholders can benefit from these types of actions. If the Commission comes to believe that these provisions improperly hinder shareholders´ exercise of their rights, it may need to weigh in more directly in this discussion, as it did with indemnification under the Securities Act.[33]

Conclusion

Let me stop here. What I have been advocating a bit today is a more open, constructive and balanced approach between companies and their shareholders. Companies should continue toward greater engagement with their owners, and carefully listen to their views. Activists should act responsibly and according to the rules. The strategic creativity of lawyers on either side may not always best serve the public interest. Upending the traditional roles of management, boards, and shareholders should not be the objective. Companies need their management and boards focused on their "jobs" so they can deliver shareholder value and contribute to the economic growth and innovation on which our country has always depended. But resisting all change, stonewalling every overture or ignoring the views of shareholders is also not acceptable or productive. Constructive engagement should be everyone´s goal.

Thank you. Enjoy your conference.