Our faculty member Christine Allie published a nice commentary in the Wilmington News-Journal over the weekend on the public benefits of the Earned Income Tax Credit.
Our faculty member Christine Allie published a nice commentary in the Wilmington News-Journal over the weekend on the public benefits of the Earned Income Tax Credit.
We’ve embarked on an interesting new course here: a series of classes led by experts in a variety of aspects of whistleblowing. Our first class featured Jordan Thomas, currently at Labaton Sucharow in New York, and formerly the Assistant Director of the SEC’s Division of Enforcement. Jordan led the students through a terrific exercise in identifying competing policy considerations behind the Dodd-Frank whistleblowing program and the SEC’s implementing rules. [For a recent story on the SEC’s whistleblower program, see this write-up by John Kiernan for CardHub.]
Yesterday’s class was led by Virginia Gibson, currently with Hogan Lovells in Philadelphia, and former director of the civil division of the U.S. Attorney’s office in Philadelphia. She brought her extensive enforcement experience to introduce students to the qui tam provisions of the False Claims Act, which permit citizens to initiate litigation asserting claims of fraud against the federal government.
Having just released a working paper that sharply criticizes the “first-filed” rule in corporate shareholder representative litigation, I was struck by the fairly strict “first to file rule” in Section 3730(b)(5) of the False Claims Act. That rule apparently has its supporters, but it’s hard to see how it doesn’t inappropriately encourage whistleblowers to file claims before developing and maturely evaluating the facts. Ginny Gibson explained that situations with multiple relators (whistleblowers) are becoming increasingly common, but priority (and sharing in a potential recovery) often gets negotiated during the “quiet period” after the complaints are filed but before the Government decides whether to intervene and the complaints become unsealed. Still, I worry that the first to file rule gives the first filer an inappropriate advantage. Hat tip to my student Kerrin Cahill (Widener ’13) whose paper pointed out that the qui tam first to file rule could use a little nuance. (And hat tip to the Ruby R. Vale Foundation for its support of this series of classes).
We’re looking forward to the other speakers in this series, including former Delaware Supreme Court Chief Justice E. Norman Veasey, DuPont General Counsel Thomas Sager, and Prof. Kathleen Clark of Washington University Law School in St. Louis, who also teaches an entire course devoted to whistleblowing.
This post describes the January 2013 working paper by Chancellor Leo E. Strine, Jr., Prof. Lawrence A. Hamermesh, and Matthew Jennejohn on the subject of multi-forum litigation and forum choice rules. The post’s summary of the paper is a little more illuminating than the paper’s abstract, and a lot shorter than the paper itself.
Two seemingly disparate recent Delaware court opinions provide an intriguing contrast in the approach to judicial review of fiduciary conduct. In its very brief opinion of January 14, 2013 in Freedman v. Adams,, et al, the Delaware Supreme Court affirmed the dismissal of a claim that the directors of XTO Energy breached their fiduciary duty by awarding $130 million in executive bonuses without doing so through a stockholder-approved plan (a Section 162(m) plan) that might have permitted the company to save $40 million by deducting the cost of the bonuses for income tax purposes. The board recited the belief that insistence on granting bonuses through a Section 162(m) plan “would constrain the compensation committee in its determination of appropriate bonuses.” And, according to the Supreme Court’s opinion, “The decision to sacrifice some tax savings in order to retain flexibility in compensation decisions is a classic exercise of business judgment. Even if the decision was a poor one for the reasons alleged by Freedman, it was not unconscionable or irrational.” The opinion does not indicate that XTO provided any explanation of what constraints the stockholder-approved plan would have imposed, or why the company chose not to pay the bonuses through such a plan.
Eleven days earlier the Court of Chancery’s opinion in the Novell shareholder litigation denied a motion to dismiss claims that a disinterested, independent board of directors acted in bad faith in selling the company, because of the absence of explanation for the decision to inform the successful bidder of a sale of a line of patents while not informing a competing bidder of that sale. The court’s opinion noted:
Why the Novell Defendants did not tell Party C about the proceeds of the Patent Sale has no apparent answer in the record before the Court. That conduct, coupled with the fact that Novell kept Attachmate fully informed, is enough for pleading stage purposes to support an inference that the Board’s actions were in bad faith.
So to editorialize a bit, the Delaware Supreme Court in Freedman might have similarly said:
Why the [XTO] Defendants did not [pay the bonuses through a Section 162(m) plan] has no apparent answer in the record before the Court. That conduct, coupled with the fact that [the Board did not explain in any specific way how use of such a plan could have constrained the determination of bonus awards], is enough for pleading stage purposes to support an inference that the Board’s actions were in bad faith.
But of course, the Supreme Court didn’t say that. Were they wrong? Was the Court of Chancery wrong in Novell? Or neither – are the two opinions consistent? In which case should the courts have been more inclined to defer to board judgment?
On a clean slate, I would have thought that the executive compensation decision at issue in Freedman would be more suspect than the conduct of an arm’s length sale of the company to a third party. In Freedman, one of the recipients of the bonuses was the company’s CEO, who was also a member of the Board. Not to put too fine a point on it, the bonus payments to him were a self-dealing transaction – one perhaps well considered and justified by an independent compensation committee, but one in respect of which the motives that implicate the duty of loyalty were present. In contrast, in Novell none of the directors had any direct conflict of interest.
It’s challenging to think of a doctrinal structure in which these two opinions can co-exist.
Submitted by Prof. Paul L. Regan
In a telephonic ruling announced earlier this week in In re Complete Genomics, Inc. Shareholder Litigation, Dec. Ch., Consol. C.A. No. 7888-VCL (Nov. 27, 2012), Vice Chancellor J. Travis Laster preliminarily enjoined Complete Genomics, Inc. from enforcing a standstill agreement containing a potentially problematic “don’t ask, don’t waive” provision. This provision purported to contractually preclude the other party to the standstill agreement (identified in the hearing only as “Party J”) from making a request — either publicly or privately — to the board of Genomics that the company waive the restrictions in the standstill that otherwise prevented Party J from making an acquisition proposal for Genomics. Thus under the “don’t ask” terms of the standstill, even a polite request by Party J to Genomics for permission to make a topping bid for Genomics would itself be a breach a contract in violation of Party J’s promise not to ask for such a waiver.
Vice Chancellor Laster concluded (on a preliminary basis involving an assessment of whether the shareholder plaintiff had shown a reasonable probability of success on the merits), that Party J’s “don’t ask, don’t waive” promise was unenforceable as tending to induce a violation of the Genomics directors’ fiduciary duties to be informed in continuing to recommend a sale of control transaction to the shareholders. Said the Court: “by agreeing to this provision, the Genomics board impermissibly limited its ongoing statutory and fiduciary obligations to properly evaluate a competing offer, disclose material information, and make a meaningful merger recommendation to its stockholders.”
Party J was one of a handful of potential suitors with whom Genomics had signed confidentiality and standstill agreements before providing access to the company’s confidential financial and business information. Genomics is a biotech life sciences company that has developed and commercialized an innovative DNA sequencing platform so it made especially good sense to protect its propriety know-how and confidential financial data as part of any auction process. Following due diligence by potential bidders and the ensuing auction, Genomics entered into a merger agreement pursuant to which it agreed to be acquired in a two-step tender offer and merger transaction with a U.S-based subsidiary of Chinese firm BHI-Shenzen.
A few weeks before this most recent, decision Vice Chancellor Laster denied the shareholder plaintiff’s earlier attempt to obtain a preliminary injunction against enforcement of the Genomics merger agreement with BHI and that transaction remains pending. The effect of this latest ruling is to free Party J to make a topping bid while the BHI tender offer is outstanding. Whether Party J might make such an offer is unknowable and the Court found irreparable harm, justifying the preliminary injunction against enforcement of the standstill with Party J, in the contract’s prevention of this information from flowing to the Genomics board from Party J as a potential bidder.
In preliminarily enjoining Genomics from enforcing the “don’t ask, don’t waive” standstill with Party J in the context of a pending change of control transaction with BHI, Vice Chancellor Laster relied in significant part on former Chancellor Chandler’s bench ruling in Phelps Dodge Corp. v. Cyprus Amax Minerals Co., 1999 Del. Ch. LEXIS 202 (Sept. 27, 1999). There it will recalled, the Court reasoned that a “no-talk” provision in a merger agreement was improper because it prevented the directors of Cyprus Amax, in advance and under all circumstances, from making an informed decision whether to refuse to negotiate with potential suitor Phelps Dodge. Chancellor Chandler memorably described such a provision as improper because it was “the legal equivalent of willful blindness, a blindness that may constitute a breach of a board’s duty of care….”
In Genomics Vice Chancellor reasoned that the “don’t ask, don’t waive” provision was equivalent to “a bidder-specific no-talk clause” of the type the Court in Phelps Dodge found troublesome. The Genomics directors effectively prevented themselves from being fully informed because the standstill contractually precluded Party J from even requesting a possible waiver of the standstill so as to make a further acquisition proposal. Under those circumstances, the Court reasoned, the Genomics board could not fulfill the fiduciary obligation to be informed in continuing to recommend the BHI transaction to Genomics shareholders.
Vice Chancellor Laster made clear that a “don’t ask, don’t waive” standstill that only precluded public requests for a waiver could pass fiduciary muster so long as the agreement allowed for a private, non-public request. Under such circumstances the potential bidder has a contractually viable path forward to communicating (albeit privately) to the target its interest in making a bid. Likewise the target directors would maintain their ability to fulfill their fiduciary duty to remain fully informed in continuing to recommend an already-approved pending transaction or, if warranted, changing that recommendation in favor of a new superior proposal.
The Court’s decision in Genomics understandably relies on Phelps Dodge and perhaps a visceral aversion to contractual provisions that would seem to handcuff the board of a company undergoing a sale of control from receiving a later topping bid, or even more embryonically, from even receiving a request for permission to make a topping bid.
On the other hand, one could argue that a well-advised board of a corporation undergoing a sale of control might legitimately make use of a “don’t ask, don’t waive” standstill in furthering stockholder welfare. For example, the board of the selling corporation might ask its financial advisor to solicit interest from possible bidders, with due diligence access and subsequent auction participation conditioned on each bidder agreeing to a “don’t ask, don’t waive” standstill. Under the auction rules set out by the board, all bidders would be given a timeline, and contractual permission, for the submission of one bid and one bid only — the highest and best offer each bidder is able and willing to make. Such bids would be made with the understanding (and contractual limitation) that there would be no further rounds of bidding, and topping etc. The standstill thus would prevent any such serial attempts to bid. One could argue that such an auction arrangement could benefit stockholders by shortening the auction process and encouraging the highest and best offers up front. Any other bidder not part of the original auction process, i.e., who had not signed a standstill, could theoretically lob in a topping bid later and the board of would have to consider that new information in keeping with its fiduciary duties.
Of course one might prefer to run an auction differently than in the manner suggested above, but our law makes clear that while the directors have an obligation (in Revlon mode) to act reasonably to seek the highest value for the stockholders, there is no legally required blueprint for how to run an auction. And there’s the rub. Does a “don’t ask, don’t waive” standstill, when used as suggested above, amount to just another one of many legitimate ways to run an auction in good faith? Or, as Genomics suggest, does a “don’t ask, don’t waive” standstill cross the fiduciary line by creating an improper impediment to the realization of that value by preventing the directors from having all information reasonably available in making their continuing recommendation to stockholders?
The November 28, 2012 opinion by Vice Chancellor Laster in Feeley v. NHAOCG, LLC represents the latest round in the ongoing debate about whether those with managerial authority in Delaware LLCs have fiduciary duties as a default matter. We have addressed this issue extensively on this site, most recently in Prof. Luke Scheuer’s post about the Delaware Supreme Court’s (non)decision on this issue in Auriga v. Gatz.
Vice Chancellor Laster’s decision ratchets up one notch the Court of Chancery’s commitment to the proposition that such default duties exist. Although the Chancellor’s opinion to the same effect in Auriga now has no precedential value, Vice Chancellor Laster has now ruled the same way in a case in which the issue was squarely presented. Chancellor Strine’s discounted opinion was relied upon not as precedent, but so as to “afford his views the same weight as a law review article, a form of authority the Delaware Supreme Court often cites.”
Vice Chancellor Glasscock’s November 5, 2012 opinion in Rich v. Fuqi International, Inc. addresses the recurrent and fascinating exercise in federalism that arises when state law requires a corporation to convene an annual meeting of stockholders, but federal law forbids the necessary solicitation of proxies due to the corporation’s inability to supply the required audited financial statements. The ostensible collision makes for interesting reading, and Francis Pileggi’s blog entry on the opinion is a good place to start.
In 2008, the SEC adopted Rule 200.30-1(e)(18) in an effort to avoid the ostensible collision in a way that gave effect to the legitimate goals of both state and federal law. Simply put, the Rule permits the Director of the Division of Corporation Finance to exempt an issuer from the demands of Rules 14a-3(b) and 14c-3(a), where the corporation demonstrates that it:
(i) Is required to hold a meeting of security holders as a result of an action taken by one or more of the applicant’s security holders pursuant to state law;
(ii) Is unable to comply with the requirements of Rule 14a-3(b) or Rule 14c-3(a) … ;
(iii) Has made a good faith effort to furnish the audited financial statements before holding the security holder meeting;
(iv) Has made a determination that it has disclosed to security holders all available material information necessary for the security holders to make an informed voting decision in accordance with Regulation 14A or Regulation 14C (§§240.14a-1 – 240.14b-2 or §§240.14c-1 – 240.14c-101 of this chapter); and
Absent a grant of exemptive relief, it would be forced to violate either state law or the rules and regulations administered by the Commission.
The defendant corporation (Fuqi International) was originally sued over two years ago, having failed to convene an annual meeting since July 2008. Unable to obtain audited financial statements, Fuqi persuaded the plaintiff stockholder on multiple occasions to defer his application for relief, but the plaintiff’s patience evidently wore out earlier this year, and on June 1, 2012 he successfully obtained a formal order compelling the meeting.
Note that until this point, Fuqi’s request to the SEC staff to exempt it from the pertinent proxy rules was more than arguably a non-starter under Rule 200.30-1(e)(18), because Fuqi was not yet under legal compulsion in the stockholder action to convene an annual meeting. The Vice Chancellor’s order, however, directed Fuqi to again formally seek an exemption from the SEC, this time with an order in hand. According to Fuqi, the SEC has not yet acted on that application, leaving the company in a position of being required to solicit proxies by no later than November 17, as necessitated by the order of the Court of Chancery, but doing so at risk of violating the proxy rules.
In that context, Fuqi went back to the Vice Chancellor, not directly seeking an extension of any sort, but seeking relief permitting it to appeal to the Delaware Supreme Court, via partial judgment or certification of an interlocutory appeal. It is this application that the Vice Chancellor denied. As I read his opinion, he essentially lost patience with the extended delay in convening the meeting that Delaware law requires, and he partly blamed Fuqi for not fully pressing its exemptive application to the SEC until this June:
It also bears mentioning that Fuqi has caused the very uncertainty it now seeks to resolve. Fuqi chose to withdraw its 2011 exemption request because SEC staff purportedly suggested that a formal opinion denying the exemption would prejudice Fuqi in the SEC’s investigation into Fuqi’s original financial restatement. In withdrawing its application, Fuqi made a tactical decision to forego obtaining a formal decision from the SEC. Given that Fuqi was in the midst of negotiating this action, Fuqi was presumably aware that the lack of a final SEC decision was an important consideration of the Court’s decision in Newcastle Partners, and Fuqi should be prepared to accept the consequences of its choice.
I can see how this analysis could be frustrating to Fuqi: it’s being placed in a difficult position, and not having been subject to an order compelling it to convene meeting, there was arguably nothing it could have done before June 1, 2012 to formally pursue an exemptive application with the SEC.
But rather than criticize the Vice Chancellor, Fuqi, or the Commission, let’s step back a bit and ponder how a sensible, coordinated state and federal response to the situation should proceed – instead of proceeding as an exercise in brinksmanship, with both state and federal authorities asserting priority for their respective roles and policy concerns.
First, let’s acknowledge the utility of the Commission’s approach in adopting Rule 200.30-1(e)(18): at the very least, it affords a way for the Commission to set aside any inflexible unwillingness to permit a stockholder meeting to go forward in the absence of audited financial statements. That’s a good thing, as the Vice Chancellor reminds us, because “a stockholder’s right to a meeting is especially strong when financial management is so questionable as to delay the provision of audited financial statements for three full years.”
On the other hand, what if there’s no indication that the annual meeting will do anything other than re-elect incumbent directors in an uncontested vote? What if there’s no indication that a stockholder meeting would address concerns about inadequate leadership by the board or the senior officers of the company? In that circumstance, is the state interest in protecting the stockholder franchise a compelling consideration? Or does the Commission’s legitimate interest in promoting complete and accurate financial disclosures take priority in that circumstance, given investors’ general interest in the maintenance of such disclosures?
In an effort to answer these questions as they pertain to the present situation, I’d start by pointing out that I see nothing in the facts of the case indicating that the plaintiff holds a significant block of stock, nor anything indicating that the plaintiff intends to pursue or assist in the election of a competing slate of directors, or do anything else that would alter the composition of the board. In fact, the plaintiff and his counsel in the annual meeting suit are now pursuing a parallel derivative lawsuit in the Court of Chancery – nothing inherently wrong with that, but it’s not the usual technique for a stockholder attempting to promote a change in board composition. Anyway, and in a previous entry on this blog, I have questioned inflexible and undue obeisance to the idea that the annual meeting is indispensable.
In the pending situation, it may well be that Fuqi has satisfied the minimum requirements of Rule 200.30-1(e)(18), but surely the staff’s discretion in regard to exemptive applications doesn’t require that the exemption be granted in all cases where those minimum requirements are met. Surely the staff can and should evaluate how an exemption might or might not serve the larger interests of investors, as opposed to an abstract interest of stockholders in exercising the right to elect directors in an uncontested election.
From where I sit, then – a comfortable armchair – and based on the facts described in the Vice Chancellor’s opinion (and the facts not described there), I’d deny Fuqi’s exemption application, if I were the Director of the Division of Corporation Finance, and when Fuqi returns to the Delaware courts, as the Vice Chancellor’s order contemplated it could do, with a fully mature conflict of obligations, I’d stay the order compelling the convening of the annual meeting, subject to periodic review, unless and until it appeared that there was a reasonable prospect that the meeting would involve more than a formality of re-electing incumbent directors.
The October 15, 2012 report by the SEC pursuant to Section 504 of the JOBS Act examines the question whether the Commission has sufficient enforcement authority to address evasions of Rule 12b5-1. The new report has some provocative nuggets in it:
1. Strikingly, it reports that about 87% of companies currently in the ’34 Act reporting system by virtue of Section 12(g) (having had more than 500 stockholders of record) would not become subject to those reporting requirements under the increased threshold adopted in the JOBS Act.
2. Lest anyone rush to the conclusion that this statistic is alarming, the report (in footnote 70) cites recent empirical studies that suggest that the likely contraction of the application of reporting requirements is a good thing: according to those studies, companies not subject to public reporting obligations obviously avoid “disclosure costs related to revealing information to competitors.” Less obviously, but more interestingly, “there is also evidence that private companies have less myopic investment strategies compared to their public peers, and are more sensitive in responding to new investment opportunities.”
3. The 500 nonaccredited investor limit added by the JOBS Act creates additional detection problems, where special purpose vehicles might be used to aggregate the holdings of multiple such investors.
The report ultimately concludes that there isn’t enough information at the moment to request additional enforcement authority. It’s important to note what the new report (understandably, given the Congressional mandate) does not ask: whether tying Exchange Act registration to numbers of record stockholders makes sense any more in an age where, as the report explains, “the vast majority of investors own their securities as a beneficial owner through a securities intermediary,” unlike the system in place when the number of record holders was chosen to determine applicability of the registration requirement.
The suggestion that private companies have “less myopic investment strategies compared to their public peers” is yet more evidence that conscientious investors and managers in public companies could stand to rethink and reshape the quality of discourse about corporate performance.
We previously reported here on the voting results on proxy access shareholder proposals during the main proxy season. In the last couple months there have been three additional votes (at Forest Laboratories, Medtronic and H&R Block). As the updated voting tabulation reflects, these three most recent votes didn’t add much to any argument that the SEC’s now-invalidated 3 year/3% ownership thresholds gave shareholders less than they would have voted for themselves: we’re talking favorable votes of 8% or less of the outstanding shares, and less than 10% of the shares actually voted. That compares to the 46%-51% approval levels at Nabors Industries and Chesapeake Energy for proposals that pretty much tracked the SEC’s threshholds.
Anyway, here’s the updated tabulation:
2012 proxy access votes (updated September)