Proxy Regulation

Part 1: Shareholder Proposals

Basic Rules

• Proxy solicitations must be registered with the SEC. – Cannot make material misrepresentations or

misleading statements, e.g. • 1) predictions of future market values; • 2) impugns the character, integrity or personal

reputation or makes charges re: illegal or immoral conduct w/o factual foundation; • 3) failure to identify document as a proxy statement,

form of proxy or other soliciting material; • 4) claims re results of a solicitation.

Basic Rules

2. In proxy fights, insurgents must disclose identity once own 5% of stock, interest in company; securities financing arrangement, participation in other contests and understandings re: future employment, source of funds used, purpose for which the offer is made, plans of aggressor if successful and any contracts have re: target company.

-Duty to disclose intent and exercise care

Basic Rules

3. Defensive tactics in a typical proxy fight include: 1) move up or postpone meeting at which board will consider the offer; 2) change the record date to minimize insurgents voting power; 3) amend bylaws to make it more difficult by increasing minimum vote required to pass.

Shareholder Approval Actions Initiated by the board resolution and may require shareholder approval per

articles of incorporation or bylaws.1. ELECTION OF THE BOARD OF DIRECTORS: Directors nominate a slate of directors to

be voted on at the annual meeting for a term, (Terms can be staggered or fixed). Unless articles provide otherwise, directors may set compensation for directors and officers.

2. REMOVAL OF DIRECTORS: Shareholders may remove a director unless articles require removal for cause. Removal must be specifically noticed in the meeting. MBCA 8.08

3. RATIFICATION OF DIRECTOR ACTION: Where directors are interested and decide whether or not to bring a shareholder derivative action after written demand. Required to file a report after reasonable investigation to determine if in best interests. MBCA 7.42-7.44

Shareholder Approval forFundamental Changes

4. MERGER: 2 or more companies merger together so one is dissolved. MBCA 11.02. Requires a plan of merger that include name of co; the manner of converting the shares of the merging company; articles of incorporation, and other provisions required per the bylaws. Merger can be effected by a tender offer, i.e., share exchange or purchase. The shareholders of all classes of stock of both corporations have the right to approve per the articles of incorporation unless the corporation will survive or it is a merger of parent and subsidiary.

5. SALE OF ALL OF THE ASSETS: Shareholders have the right to approve a sale of all or substantially all of the assets outside of the ordinary course of business. MBCA 12.01

6. SALE OF STOCK: Buy controlling interest via a tender offer and

then cash-out merger.

Shareholder Approval forFundamental Changes

7.DISSOLUTION OF CORPORATION: Board or shareholders may propose to dissolve the corporation under a plan of dissolution. MBCA 14.01

8. AMENDMENT OF ARTICLES OF INCORPORATION OR BYLAWS: MBCA 10.03 Every class of shareholders affected by the action have the right to vote on the amendment.

Shareholder Proposals- Categories Governed primarily by state law, SEC 1934 implies a private action but has

higher standard to overcome. Can request no action letters from SEC. 1) Corporate Governance-structure and composition of the board, poison pills

(i.e. special class of stock created for a bidder that requires that the corporation redeem at a higher price if unsuccessful, or allows shareholders to acquire additional shares at a discount to dilute the value)-generally favorably treated by SEC in recent years. (2001-2002 @ 55.7% approve) though management tends to exclude by 47% during the same period

2) Operational-executive compensation, production/business matters, company

communications (2001-2002 @49% of proposals SEC has found includable) 3) Social/political: environmental, political, military and labor (2001-2002 @ 41.4

% included by SEC which says that most are excludable)

Shareholder Proposals

1. Notice requirements are defined by Bylaws for annual and special meetings.

2. Only one proposal per shareholder. 3. Submit proposals within 120 days of mailing.4. Proposal has to be registered with SEC and

identified as proxy. All of the pertinent information needs to be included.

5. There are word limits 500 words (e.g., 2 pp)

Reasons for Board Rejection of Shareholder Proposal

Reasons to exclude Board is not required to include any proposal in a proxy re: 1. Violate state law, 2. Contrary to proxy rules,3. Redress a personal claim or grievance, 4. Relates to operations of less than 5% of total assets,- Unrelated to co business-5. Deals with ordinary business operations,6. Relates to election of office,7. Counter to proposal submitted by majority board- not required to submit conflicting proposals or

duplicative, 8. Similar to previous proposals- that have failed in the past9. Relates to specific cash or stock dividend.10. Not a proper subject- asks that a study be conducted without compelling specific action11. Beyond the authority of the corporation12. Moot because the board is already doing it.

Reasons to Reject Tender Offer A board may legitimately defeat a tender offer; (and can also include offers to sell substantially

all of the assets of the corporation; or other actions that require an exercise of business judgment) for following reasons:

1) offer price is too low and doesn't reflect the true value of the shares or assets;2) offeror has a bad reputation for unsound management;3) offeror is assuming obligations that it cannot meet w/o selling corp. assets and therefore

injuring remaining shareholders; 4) it is in the best interests of corporation to say no;5) management has a long range plan to improve corporation profits and decision is protect

by business judgment rule;6) transaction results in antitrust issues;7) offer is partial 2-tier offer and will result in unfair coercion of shareholders by forcing them

to tender;8) conflicts with a competing proposal adopted by the board.

Case Rules

• Rauchman: A corporation may properly refuse to include proposals related to the election of specific officers and directors.

Questions• George presents a liquidation proposal to GPI’s board and

shareholders that is soundly defeated at the shareholder meeting. As the next annual meeting approaches, he wants to shake up the way in which GPI does business. Which of the following would be includable under the shareholder proposal rule?

1) A proposal that shareholders elect George as a new director to the board.

2) A resolution stating the shareholders’ desire that management nominate at least two women to the board.

Questions• George presents a liquidation proposal to GPI’s board and shareholders

that is soundly defeated at the shareholder meeting. As the next annual meeting approaches, he wants to shake up the way in which GPI does business. Which of the following would be includable under the shareholder proposal rule?

3) A resolution stating that the shareholders’ desire that management nominate more women to the board.

4) A resolution requiring the board to prepare a report on affirmative action

in the company’s management training program. 5) A resolution urging the board to adopt a policy that GPI not sell products

from countries that rely upon child labor. Although such products account for a small part of GPI’s business George feels that it is immoral.

Questions6) A proposal to sell substantially all of the assets of the

corporation to a third party. 7) A contract for goods that will impair 10 percent of the

corporation’s assets and operating budget. 8) A proposal to consider a tender offer from a third

party for stock.

Proxy Regulation

Part 2

Proxy RegulationRelates to the use of interstate commerce to solicit proxies or consent

or authorization. Designed to prevent overreaching by management.

1) Must file a registration before the broker can effect transaction on

national exchange. 2) Prohibits false or misleading information in proxy solicitations and

statement. 3) Proxy must be for specific: notice of the meeting and fully disclose

the proposed action and options regarding voting.

Proxy Solicitation RulesIt is a violation of SEA 14a to include false or misleading

material facts or omit material facts in proxy statement. Cannot

1) Predictions about future market values;2) Impugn character, integrity, or personal reputation; ormake charges regarding illegal and immoral conductwithout factual foundation;3) Failing to identify a proxy statement, form of proxy orother soliciting materials; or4) Claims regarding results of a solicitation.

Proxy Regulation1. Proxy can allow person to vote in a specific way for or against

a proposal, leave to the discretion of the board to vote shares. You can show up and defeat proxy submitted.

2. Expenses for proxy fight have to be borne by the person submitting the proposal. If they are successful, and take over

3. the board, then can request reimbursement. Can request no action letter from the SEC that the request was properly excluded.

4. If management collects proxies that give them authority to vote on matters within their discretion, then if a motion from the floor is made and supported by shareholders, then the board can use its discretion whether to approve or not.

Case Rules

• TSC: Test of materiality in misrep. in proxy statements requires that there be a substantial likelihood that a reasonable SH would attach importance to the material in deciding how to vote.

Proxy Fraud

Part 3

Proxy Fraud1. Misrepresentation or omissions, include opinions, motives and reasons are actionable unless

you can show speaker believes the opinion is correct, or there is a basis for making the opinion, and speaker knows nothing to contradict. (Va. Bankshare)

2. Materiality establishes reliance, so reliance need not be specifically

proved. (TSC) Materiality is an objective standard that a reasonable person believes that the event will likely occur and attaches importance to it.

3. Loss Causation- “Essential link in the transaction,” so vote is

necessary and transaction has harmed the shareholders. (Va. Bankshare)

4. Intent- not required. Negligence is enough if the transaction has

resulted in a loss.

Proxy Fraud • Rule 14a of SEC fills the gap left by state private action

for fraud (common law) and breach of duty of good faith.

• Implied private action under Rule 14a. Derivative action still available where demand. Sue to compel correction.

• Plaintiffs prefer to sue under federal law to avoid derivative action, having to make the demand, bjr, and appraisal remedy.

• Opinions are not actionable under state law. • Remedy can be prospective ,e.g, injunction, or

retroactive, to invalidate or rescind the transaction. • Attorney fees can be awarded

Rule re Opinions

1) If an opinion is misleading, but the directors believe it is correct and there is nothing to suggest that they do not believe it, then it will not be actionable under proxy fraud, even if it is actionable under 10b5 or breach of fiduciary duty.

2)Because the requirement of materiality for proxy fraud requires a statement of fact, an opinion is only going to be material if it is stated in such a conclusory fashion so it is reasonable that a shareholder would attach importance to it as a fact.

3) If it is a statement of fact is misleading, even if the directors did not intend for it to be, it is actionable.

Causation

• Transaction causation requires that the must be a solicitation of a vote, and injury to the shareholders in exercising right to vote, e.g. drop in price or loss of appraisal right.

• Loss causation, e.g. harm to the shareholder; and transaction causation, in that the vote has to be required. – Intent is not required; negligence is enough.

E.G. of Causal Link

THE CAUSAL LINK THAT MAY BE SATISFIED, ALONG WITH REMEDY TO REQUEST

ELECTION OF BOARD QUALIFICATIONS, MISDEEDS, SELF-

DEALING, ACTIVITIES ENJOIN, NEW ELECTION, EXPULSION SALE OF ASSETS, MERGERS, SHARES PRICE, INTENT OF BUYER,

EFFECT OF TRANSACTIONDAMAGES, ENJOIN, RESCIND COMPENSATION PLANS REASONABLENESS, QUALIFICATIONS,

PERFORMANCE BENCHMARKS, COST RESCIND, TERMINATION

State Fraud

• Requires: 1) actual misrepresentation of fact, not just deceptive opinion or omission; 2) mgmt knew of the falsity;3) shareholders actually read and relied on them; and 4) actual damages because of reliance.

Questions1. GPI is a multinational paper products company. Its stock is listed on the NYSE.

Sara, a GPI shareholder is upset when she reads a newspaper account of the hefty pay package of GPI’s chief executive officer. Sara claims the CEO’s pay is waste of corporate assets and the board failed to fully disclose the CEO’s sizeable stock options in the company’s most recent proxy statement.

a. Sara sues in state court claiming federal proxy fraud, state fraudulent

misrepresentation, and breach of fiduciary duty. Any problems with the suit? b. SEC rules require that executive compensation be fully disclosed in the

company’s proxy statement. Schedule 14A, Item 8 and 10. Does Sara have standing to sue for violation of the SEC’s line item disclosure requirements?

Questions2. Sara sells her GPI stock after reading the company’s proxy statement for

the annual election of directors that states “management anticipates company earnings will remain flat for the next two years.” At the time GPI management is secretly buying GPI shares at depressed prices on the open market. In fact, earnings increase dramatically, a turn of events management was expecting.

a. Does GPI management violate the proxy rules by making a misleading

prediction? b. Sara sold her shares before she had a chance to vote. Does shareholder

have an implied right of action under the federal proxy rules?

Questions3. GPI management is under investigation by the FBI for bribing

environmental regulators with authority over the company’s paper-processing operations. Although management is aware of the investigation, the company’s proxy statement for the upcoming election of directors does not mention it. She could not pursue a derivative action either because she is no longer a shareholder.

a. The FBI investigation is ongoing, and no charges have been brought against the company or its officials. Does failure to disclose the investigation violate the proxy rules?

b. Sara sues under the proxy rules to enjoin the shareholders’ meeting pending a corrected proxy statement. Assuming the investigation was material, does Sara have to show management intended to deceive?

Questions

c. In her suit to enjoin the shareholders’ meeting, does Sara have to prove that a majority of shareholders actually read the proxy statement and relied on it?

d. After the election, the FBI concludes its investigation and finds the GPI directors illegally approved the bribes. Will she succeed if she sues them on behalf of the company under the proxy rules?