The 2014 proxy season reintroduced many traditional corporate governance topics to corporate ballots, and also generated new calls for reforms to the shareholder proposal process generally. In addition, activist investors continued their robust efforts to change corporate strategies and governance practices in 2014 – many with continuing success, despite calculated defensive efforts by targeted companies.
Investors continued their calls for changes to corporate governance and compensation practices in the 2014 proxy season, submitting more than 800 separate proposals for inclusion on corporate ballots. Governance-related proposals, which constituted roughly 40 percent of the proposals submitted to S&P 1500 companies in 2014, covered traditional topics such as board declassification, independent board chairs and shareholders’ right to call special meetings. As in years past, those proposals generally garnered high levels of shareholder support.
Roughly half of the shareholder proposals submitted in 2014 addressed environmental or social issues such as political activities and climate change. Consistent with past years, those proposals typically garnered relatively low levels of shareholder support. Despite the low success rates for environmental and social proposals, however, shareholders continue to submit proposals on those topics year after year.
As in past years, the majority of 2014 shareholder proposals were submitted by pension funds, unions and other institutional investors. Remarkably, however, almost 20 percent of the proposals submitted in the 2014 proxy season were sponsored by John Chevedden and Kenneth Steiner, perennial retail activists who typically hold only a nominal amount of shares in the companies they target.
Although many shareholder proposals have no rational relationship to the creation of shareholder value, the flood of proposals submitted by corporate gadflies and investment funds pursuing special interests shows no sign of abating. Shareholder proposals cost U.S. companies tens of millions of dollars each year, including the costs involved in negotiating with proponents, seeking SEC no-action relief to exclude proposals from proxy statements, and in preparing opposition statements. Of course, companies also spend millions more to implement successful shareholder proposals or to seek to mitigate the very real consequences – including withhold vote recommendations from proxy advisory firms – for failing to do so. Moreover, the voting policies of proxy advisory firms typically define a “successful” proposal as one that wins a majority of votes cast, which in many cases is far less than a majority of the outstanding shares.
In the 2014 proxy season, several companies brought their disputes over shareholder proposals – in many cases proposals submitted by retail investors – to the courtroom rather than pursuing SEC no-action relief. This approach, which has gained popularity in recent years, may signal companies’ frustration with the SEC’s no-action process and abuses of the shareholder proposal system. For example, several companies challenged Mr. Chevedden’s approach of being designated as the “proxy” for another shareholder – in essence, renting shareholder status to pursue social interests that, while possibly laudable, do not really serve corporate interests. Further, a number of companies challenged Mr. Chevedden’s proposals on the basis that the proposals included false and misleading statements. Although many claims were dismissed on the grounds that the company failed to demonstrate imminent injury, at least two claims resulted in favorable rulings. One company won declaratory relief (which was upheld on appeal) against Mr. Chevedden’s “proposal-by-renter-rather-than-owner” approach. Another company won declaratory relief after the SEC previously denied no-action relief for the exclusion of a proposal that included inaccurate statements about the company’s executive compensation, corporate governance policies, and director election results. Although outcomes in shareholder proposal litigation may not be more predictable than those achieved through the SEC no-action process, some companies may continue to view litigation as a viable alternative for addressing perceived abuses of the shareholder proposal process.
In our view, the SEC’s Rule 14a-8 shareholder proposal system is antiquated, and we are not alone in the view that serious reform is required. This spring, SEC Commissioner Daniel Gallagher publicly criticized the Rule 14a-8 process, including the “absurdly low” holding requirement of $2,000 worth of shares, the loose requirements for proposal topics, and the lack of guidance available to the SEC staff for determining when to grant no-action relief – and the resulting inconsistency in staff positions. Commissioner Gallagher also challenged the low thresholds for resubmission of shareholder proposals – at most, proposals require only 10 percent support to permit resubmission in the following year.
Several business associations have also called for changes to the Rule 14a-8 process. In April 2014, the U.S. Chamber of Commerce, the National Association of Corporate Directors, and other groups questioned the low resubmission thresholds for shareholder proposals in a petition for SEC rulemaking. Those groups asserted that the current rules fail to preclude repeated shareholder proposals that have no realistic likelihood of winning the support of a substantial percentage of shares, resulting in a “tyranny of the minority” in which a small number of shareholders can continuously override the will of the holders of 90 percent of shares, by forcing attention – and expenditures – on Quixotic missions.
Of course, the SEC has a substantial backlog of Dodd-Frank rulemaking initiatives, and a full-scale reform of the rules relating to shareholder proposals may not be forthcoming any time soon. We hope, however, that continuing calls for reform may spur real change in this area, beginning with a simple amendment to increase the proposal resubmission thresholds to a more appropriate level.
An interesting development in the 2014 proxy season was the Delaware Chancery Court’s refusal to grant an activist investor’s motion to enjoin Sotheby’s annual meeting pending the resolution of the investor’s lawsuit relating to Sotheby’s shareholder rights plan, or so-called “poison pill.” The litigation was part of a months-long activist campaign by a 9.3 percent shareholder to secure board representation and governance changes at Sotheby’s.
After the investor built its ownership stake, Sotheby’s board adopted a rights plan. The rights issued under the plan would be triggered if a person or group acquired 10 percent of Sotheby’s shares, except that passive investors (Schedule 13G filers) were permitted to acquire up to a 20 percent stake. The activist then launched a proxy contest for the election of three directors to Sotheby’s 12-member board at its 2014 annual meeting.
When Sotheby’s refused to waive the rights plan’s 10 percent trigger, the activist sued, asking that the court declare the rights plan unenforceable or require Sotheby’s to permit it to acquire a 20 percent stake. The complaint noted that it was not seeking control of Sotheby’s, but merely seeking to elect a “short slate” of directors to its board. In addition, the investor contended that, under the Unocal standard, the adoption of a rights plan with a lower triggering threshold for non-passive investors was not a reasonable or proportionate response to a shareholder who merely wished to purchase additional shares, conduct a proxy contest, and communicate with other shareholders.
The court ruled in Sotheby’s favor and denied injunctive relief. While the court ruled only on the issue as to whether a preliminary injunction was warranted – and not on the issues of whether Sotheby’s directors had breached their fiduciary duties or whether the rights plan was valid – the ruling suggests that directors who adopt a rights plan in the face of activism can reasonably determine that there is an objectively reasonable and legally cognizable threat to the company, and that a rights plan is a reasonable response to that threat.
But this good news on the apparent viability of rights plans in the presence of activism belies the larger question: Are rights plans an effective tool in these circumstances?
The decision to adopt a rights plan in the face of activism for a short slate is a complex and highly nuanced decision. As we know, rights plans continue to face consistent opposition by proxy advisory firms and others, who readily control at least 20 percent to 30 percent of the vote. Further, in our experience, many activists are loathe to exceed a 10 percent ownership threshold in the first place because the Section 16(b) short-swing profit rules place a serious limitation on their ability to exit their positions within a six-month window. There are numerous additional considerations as well, but the Sotheby’s situation teaches us that even a rights plan that survives enhanced scrutiny may still not be an effective remedy for every activism situation.
Although the denial of injunctive relief was a loss, the activist’s litigation strategy ultimately allowed it to achieve its goals. As part of a settlement reached on the eve of the annual meeting, Sotheby’s agreed to adjourn its annual meeting until later in May, to expand its board to 15 members, and to give the activist the three board seats it originally sought. In addition, Sotheby’s agreed to terminate its rights plan as of the date of the adjourned meeting and to permit the investor to acquire up to a 15 percent stake in Sotheby’s while the plan remained in effect. Sotheby’s won victories of its own, as its CEO retained his position and the investor withdrew its litigation relating to the rights plan.
Ultimately, the Sotheby’s campaign may best serve to demonstrate how many activist disputes are not won in the courtroom, but rather solved and settled in the boardroom. Although this contest settled, it presents some interesting lessons in dealing with activism. First, the court’s opinion cited numerous emails from both sides that surely weren’t drafted with a view to public disclosure – a reminder that private communications can be aired publicly, particularly when lawsuits are filed. Some of the emails produced in the litigation were written by Sotheby’s directors, and the content and tone of certain emails may have given the activist the leverage it needed to win board representation. Second, the Sotheby’s campaign demonstrates that lawsuits can be used effectively as ammunition in the activism context – especially in the context of an impending shareholder meeting – whether or not the lawsuit is a technical success. Third, although the court did not rule on the validity of Sotheby’s rights plan, some would suggest that the court’s opinion can be read as an endorsement of rights plans to defend against activist tactics. But perhaps most importantly, this matter shows once again the remarkable tenacity of activists in today’s market – the investor ultimately won the three board seats it originally sought, despite Sotheby’s apparent victory in the litigation.
Lizanne Thomas, Partner-in-Charge of Jones Day’s Atlanta office and head of the firm's corporate governance team, has roots as an M&A lawyer but practices, teaches, and lives corporate governance. She participates in more than 100 board meetings per year as counsel to a number of public companies and has lectured on governance to leading business organizations, companies, and universities throughout the world. Ms. Thomas represents special committees in going-private and other control transactions, as well as internal investigations involving issues from financial restatements to allegations of executive misconduct. She is a member of the board of directors of Krispy Kreme Doughnuts, Inc. (NYSE: KKD), where she serves as chair of the Governance Committee and member of the Audit Committee.