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.