– Liz Dunshee

Shareholders are increasingly sending a Section 220 “books & records” demand as a first step in derivative complaints – and companies need to tread carefully when responding. A recent opinion from the Delaware Court of Chancery lays out some good techniques.

In Pennsylvania Transportation Authority v. Facebook, the court denied two books & records demands where the shareholders were seeking to investigate whether Facebook’s board breached its fiduciary duties by overcompensating executives. The shareholders also said they wanted the info to inform themselves about a say-on-pay vote, communicate with directors & other shareholders about pay issues and assess director independence, which didn’t fly with the court.

This Wilson Sonsini memo explains:

Vice Chancellor Slights explained that because duty of care claims were barred by Facebook’s customary exculpatory charter provision, the plaintiffs had to demonstrate a credible basis to infer a potential breach of the board’s duty of loyalty. The plaintiffs did not claim the directors were conflicted or lacked independence, and therefore they had to argue bad faith: that Facebook’s executive compensation decisions were so “inexplicable… that bad faith—a motive other than the interest of the Company—must be at work.”

The shareholders didn’t meet that standard – in part because the directors had reviewed peer data & received “expert guidance” from a compensation consultant. The memo continues:

The court also found that, even if the plaintiffs had stated a proper purpose to investigate mismanagement, Facebook had already produced all “necessary and essential” records to fulfill that purpose. Before the lawsuit, Facebook had voluntarily produced certain board materials (minutes and presentations) relevant to the advertising metric errors, which showed that Facebook’s audit committee had discussed those errors and taken measures to address them. But Facebook otherwise stipulated that the directors did not consider the advertising metric errors when setting executive compensation. Vice Chancellor Slights concluded that the plaintiffs therefore had “the information they need[ed]” to decide whether to bring a duty of loyalty claim.

Finally, the court found that none of the plaintiffs’ secondary purposes for the demands was proper. The court rejected the stated purpose of contacting directors and stockholders about compensation decisions, explaining that “a conclusory statement that plaintiffs wish to discuss compensation issues with the board and/or stockholders is not a key to unlock more information than the company has already provided.”

The purpose of deciding how to vote on “Say on Pay” was also improper because the 2019 vote had passed and it was unclear what issues would be relevant for future votes. On the plaintiffs’ request for director independence questionnaires to assess board independence, the court explained, “[b]ecause there is no credible basis to suspect wrongdoing, Plaintiffs are not entitled to determine whether the Board is independent for purposes of considering a demand to bring claims related to such wrongdoing.”

– Liz Dunshee

Director pay has been getting more scrutiny lately – but this Skadden memo covers one procedural bright spot for companies. Here’s the intro:

On October 30, 2019, the Delaware Court of Chancery struck a major blow against the plaintiffs’ bar’s efforts to lower the statutory hurdle to maintaining stockholder derivative claims. A stockholder of Ultragenyx Pharmaceutical Inc. claimed that the company’s board of directors had awarded its non-employee directors excessive pay.

Under applicable Delaware law, a stockholder asserting such a claim has two mutually exclusive options: make a pre-suit demand on the board or plead with particularity the reason it would have been futile to do so. A stockholder who makes a pre-suit demand may not later claim demand futility, but instead must make the more difficult claim that the board wrongfully refused the demand, which is essentially a business judgment analysis.

Plaintiffs have been taking a dual-track approach – by sending pre-suit letters to boards that meet the requirements of a demand and “suggest” that the board take remedial action – while at the same time expressly stating that the letter isn’t a demand, so they can preserve the “futility” pleading.

The Chancery Court sees through these shenanigans! They permitted the Ultragenyx board to treat a letter as a demand and deferred to the board’s decision not to pursue the allegations.

– Liz Dunshee

Here’s the big news that our colleague John Jenkins wrote about today on TheCorporateCounsel.net: Yesterday, the SEC issued two controversial rule proposals that, if adopted, would significantly modify the proxy disclosure & solicitation process. There’s a lot to cover, so I’m going to do these one at a time. First, the SEC announced a rule proposal that would impose disclosure & other obligations on proxy advisors. The proposed rules would:

– Amend Exchange Act Rule 14a-1(l), which defines the terms “solicit” and “solicitation,” to specify the circumstances when a person who furnishes proxy voting advice will be deemed to be engaged in a solicitation subject to the proxy rules.

– Revise Rule 14a-2(b) to condition certain exemptions relied upon by proxy advisors on their compliance with three new requirements. In order to avoid complying with the full range of rules applicable to proxy solicitations, proxy advisors would have to disclose material conflicts of interest in their proxy voting advice, provide the company with an opportunity to review and comment on their advice before it is issued; and, if requested by the company, include in their voting advice a hyperlink directing the recipient of the advice to a written statement that sets forth the company’s position on the advice.

– Modify Rule 14a-9 to include examples of when failing to disclose certain information in the proxy voting advice could be considered misleading within the meaning of the rule.

The SEC was sharply divided on this proposal & its companion – both of which were approved by a 3-2 vote. Commissioner Jackson issued a statement on his decision to dissent from the proposal, which he characterized as limiting the ability of investors to “hold corporate insiders accountable.” Fellow Democratic Commissioner Allison Herren Lee issued a statement in which she said that both proposals would “suppress the exercise of shareholder rights.” In particular, she expressed concern that it would cause a 5-day delay for voting recommendations – if true, that would mean a lot of institutional investors wouldn’t vote until right before the meeting and companies would have very little time to react or follow up to request changes.

In contrast, Republican Commissioner Eliad Roisman issued his own statement in support of the proposal, which he said would help fiduciaries “receive more accurate, transparent, and complete information when they make their voting decisions.”

When Caesar crossed the Rubicon with his legions in 49 BC, he knew that he was taking a fateful step and reportedly exclaimed “Alea iacta est!” – “The die is cast!” Maybe I’m being a little dramatic, but it sure feels like there’s an element of that sentiment in the SEC’s action. While Commissioner Clayton issued a statement in which he stressed that the proposal is just that – a proposal – it seems inevitable that the regulatory ground is about to shift in a significant way.

But Wait! There’s More! SEC Proposes to Tighten Shareholder Proposal Thresholds

Because one highly controversial proposal wasn’t enough, the SEC also announced a rule proposal yesterday that would make it more difficult for shareholders to submit & resubmit proposals for inclusion in a company’s proxy statement. The rule proposal would, among other things:

– Amend Rule 14a-8(b) to replace the current $2,000/1% ownership for at least 1 year threshold with 3 alternative thresholds for submission: continuous ownership of at least $2,000 of the company’s securities for at least 3 years; at least $15,000 of the company’s securities for at least 2 years; or at least $25,000 of the company’s securities for at least 1 year.

– Amend Rule 14a-8(c) to apply the one-proposal rule to “each person” rather than “each shareholder,” which would effectively prohibit a shareholder-proponent from submitting one proposal in their own name and simultaneously submit another proposal in a representative capacity. Representatives would also be prohibited from submitting multiple proposals, even if the representative were to submit each proposal on behalf of different shareholders.

– Amend Rule 14a-8(i) to increase the current thresholds of 3%, 6% and 10% for resubmission of matters voted on once, twice or three or more times in the last five years to 5%, 15% and 25%, respectively. A new provision would also be added permitting exclusion of a proposal that’s received 25% approval on its most recent submission if it has been voted on 3 times in the last 5 years and both received less than 50% of the votes cast and experienced at least a 10% decline in support.

Other proposed changes to Rule 14a-8(b) would subject shareholders using representatives to enhanced documentation requirements with respect to the authority of those agents, and require shareholder-proponents to express a willingness to meet with the company and provide contact & availability information.

I’ve already noted the reaction of individual SEC commissioners to these two proposals, but outside commenters had plenty to say as well. For instance, the CII decried the proposals as apparently “intended to limit shareholders’ voice at public companies in which they invest,” while the U.S. Chamber of Commerce hailed them for ensuring that “investors will have access to transparent and unconflicted proxy advice as well as improv[ing] the proxy submission process.”

– Liz Dunshee

As our colleague John Jenkins blogged today on TheCorporateCounsel.net – and as noted yesterday on its blog – Glass Lewis has posted its 2020 Voting Guidelines. As always, page 1 of the Guidelines summarizes the policy changes – and we’ll be posting memos in our “Proxy Advisors” Practice Area. Compensation-related changes include:

1. Compensation Committee Responsiveness: Glass Lewis codified additional factors we will consider when evaluating the performance of compensation committee members. Specifically, they’ll recommend against all members of the compensation committee when the board adopts a frequency for its advisory vote on executive compensation other than the frequency approved by a plurality of shareholders.

2. Severance & Change-in-Control: Glass Lewis clarified its approach to analyzing both ongoing and new contractual payments and executive entitlements. It typically disfavors contractual agreements that are “excessively restrictive in favor of the executive” – including excessive severance payments, new or renewed single-trigger change-in-control arrangements, excise tax gross ups and multi-year guaranteed awards. The extension of these provisions through renewed or revised employment agreements is also frowned upon.

3. Say-on-Pay Engagement: Glass Lewis expanded its discussion of what it considers to be an appropriate response following low shareholder support for say-on-pay – including differing levels of responsiveness depending on the severity & persistence of shareholder opposition. They expect robust disclosure of engagement activities and specific changes made in response to shareholder feedback. Absent such disclosure, Glass Lewis may consider recommending against the upcoming say-on-pay proposal.

4. Gender Pay Equity: Glass Lewis will review on a case-by-case basis proposals that request that companies disclose their median gender pay ratios (as opposed to proposals asking that such information be adjusted based on factors such as job title, tenure, and geography). In instances where companies have provided sufficient information concerning their diversity initiatives – as well as information concerning how they are ensuring that women and men are paid equally for equal work – it will typically recommend against these resolutions.

5. Other Clarifications: The Guidelines define situations where Glass Lewis reports on post-fiscal year end compensation decisions (pg. 31), sets expectations for disclosure of mid-year adjustments to STI plans (pg. 33-34) and enhances the discussion of excessively broad definitions of “change in control” in employment agreements (pg. 36).

– Liz Dunshee

Last spring, I blogged that CalPERS was considering a change to its proxy voting guidelines that would result in it voting “against” compensation committee members in the same year that it votes against say-on-pay or compensation plans. Its recently updated Proxy Voting Guidelines confirm that policy – and as Broc has blogged, the pension fund voted against 53% of say-on-pay proposals last year! So that could translate into a lot of “no” votes for directors in the coming season.

This Proxy Insight memo (pg. 7) points out that CalPERS isn’t even close to being the most “aggressive” public pension fund out there when it comes to say-on-pay votes. The Minnesota State Board of Investment voted against 69% of say-on-pay proposals in the Russell 3000, followed by the Florida State Board of Administration – which voted against 64% of proposals – and Calvert Research & Management – which voted against 57%. This MSCI blog points out that negative votes are becoming more common among other pension funds too.

Conversely, the opposite end of the spectrum is dominated by fund houses, including giants like BlackRock, Vanguard and State Street – who supported 97%, 94% and 89% of say-on-pay proposals. Proxy Insight notes that while there are exceptions in both directions, it seems that pension funds are the ones most likely to take a hard line.

– Broc Romanek

Here’s something that Liz just blogged over on TheCorporateCounsel.net: The gloves are off. Yesterday, ISS announced that it had filed this lawsuit against the SEC – which challenges the Commission-level guidance that was issued back in August. As Broc blogged earlier this week, CII had already sent a couple of comment letters to the SEC to complain about that guidance. This lawsuit also comes on the heels of the SEC announcing that it will hold an open Commission meeting next week to propose rule changes for proxy advisors.

These are the ISS allegations (also see this Cooley blog – and this Twitter thread from Wharton Prof David Zaring that speculates this case may be used as part of the bigger picture pushback on regulatory guidance that we’ve been seeing):

– The guidance exceeds the SEC’s statutory authority under Section 14(a) of The Securities Exchange Act of 1934 and is contrary to the plain language of the statute; the provision of proxy advice is not a proxy solicitation and cannot be regulated as such

– The guidance is procedurally improper because it is a substantive rule that the SEC failed to promulgate pursuant to the notice-and-comment procedures of the Administrative Procedure Act

– The guidance is arbitrary and capricious because, even though it marks a significant change in the regulatory regime applicable to proxy advice, the SEC has denied that it is changing its position at all. The agency has thus flouted the basic requirement of reasoned decision-making that it at least display awareness that it is changing its position