Professor Bainbridge...on law, politics, religion, culture & food

Bebchuk’s Electronic Arts Proposal: A Critique

The latest victim of Lucian Bebchuk’s shareholder activism crusade is video game maker Electronic Arts (maker of the iconic Madden 09 NFL game, which rocks BTW, and a host of other products for PCs, Xboxes, Playstations, and the like). Bebchuk is using Rule 14a-8 in an attempt to put the following proposal on EA’s proxy statement for the upcoming shareholder meeting:

RESOLVED that stockholders of Electronic Arts, Incorporated recommend that the Board of Directors, to the extent consistent with its fiduciary duties, submit to a stockholder vote an amendment to the Corporation’s Certificate of Incorporation or the Corporation’s Bylaws that states that the Corporation (1) shall, to the extent permitted by law, submit to a vote of the stockholders at an annual meeting any Qualified Proposal to amend the Corporation’s Bylaws; (2) shall, to the extent permitted by law, include any such Qualified Proposal in the Corporation’s notice of an annual meeting of the stockholders delivered to stockholders; and (3) shall, to the extent permitted by law, allow stockholders to vote with respect to any such Qualified Proposal on the Corporation’s proxy card for an annual meeting of stockholders. “Qualified Proposals” refer in this resolution to proposals satisfying the following requirements:

(a) The proposal was submitted to the Corporation no later than 120 days following the Corporation’s preceding annual meeting by one or more stockholders (the “Initiator(s)”) that (i) singly or together beneficially owned at the time of submission no less than 5% of the Corporation’s outstanding common shares, (ii) represented in writing an intention to hold such shares through the date of the Corporation’s annual meeting, and (iii) each beneficially owned continuously for at least one year prior to the submission common shares of the Corporation worth at least $2,000.00;

(b) If adopted, the proposal would effect only an amendment to the Corporation’s Bylaws, and would be valid under applicable law;

(c) The proposal is a proper action for stockholders under state law and does not deal with a matter relating to the Corporation’s ordinary business operations;

(d) The proposal does not exceed 500 words; and

(e) The Initiator(s) furnished the Corporation within 21 days of the Corporation’s request any information that was reasonably requested by the Corporation for determining eligibility of the Initiator(s) to submit a Qualified Proposal or to enable the Corporation to comply with applicable law.

EA has declined to include the proposal and Bebchuk has sued (where’s he getting the money to finance his multiple lawsuits against corporations is a question for a good investigative reporter). The case is now before a US District Court in New York.

Jeff Gordon has a post linking all the briefs and discussing the key issues. Gordon Smith and Larry Ribstein have also posted on the case, as I have (see below).

The case has attracted a lot of attention, including several amicus briefs. Among the amici curiae is a group of 46 corporate and securities law professors, most hailing from elite schools. (Oddly enough, I was not asked to sign, despite being one of the 100 most influential people in corporate governance.  ) Their brief focuses not on the substantive issues raised by the proposal, but on the initial question of whether EA is legally obliged to include the proposal on its proxy statement.

I recognize that those who signed the brief are not necessarily endorsing Bebchuk’s proposal. At the very least, however, they are enabling Bebchuk’s activist campaign.

Many of the 46 are friends of mine, for whom I have both affection and respect, so I criticize them with some trepidation, but they’re advancing a pernicious cause.

Let us assume the following: 

• The proposal passes


• EA’s board agrees to put the proposed amendment to the articles on the ballot


• The amendment passes

What might happen next? Well, consider that sex and violence in video games is an issue that has attracted widespread attention. Pope Benedict XVI, for example, says that video games “and other media that exalt violence and trivialize sexuality is a perversion, especially when directed at young people.” Now bring onto the scene a wealthy social conservative, such as Domino’s Pizza founder Tom Monaghan, who helped launch the Ave Maria funds, which are “targeted at investors seeking to place their money in companies whose operations are in keeping with the core teachings of the Catholic Church. The fund calls their shareholders ‘morally responsible investors.’” The Ave Maria funds set “religious criteria that screen companies before the funds will invest in them. Involvement with contraception, non-marital partner employee benefits, pornography, and abortion are some issues that disqualify a company from the fund.” Suppose the funds decide to take a more active role in fighting these causes. They start investing in companies that produce, say, video games with sex and violence so as to use the shareholder proposal rule to pressure companies to stop making such games, just as social activists have long used Rule 14a-8 to pressure companies to change their behavior on a host of social issues.

The Ave Maria funds put forward a proposal to amend the bylaws in a way that would require EA to stop making games rated for mature audiences.

In the absence of Bebchuk’s proposal, it’s uncertain whether the proposal could be excluded from the proxy statement if management objected. The company will argue (1) that the proposal can be excluded under 14a-8(i)1), because it is not a proper subject for shareholder action. There is a well known conflict in the Delaware code between the sections governing bylaws (109) and the powers of the board (141). The recent CA case suggests that, at least in some cases, the director primacy norms embedded in section 141 trump shareholder rights to adopt bylaws. Likely, this would be the case with respect to a bylaw that tried to preclude the corporation from engaging in a certain line of business.

The company will also argue that (2) the proposal can be excluded under the economic significance test in Rule 14a-8(i)(5) and the ordinary business exception in Rule 14a-8(i)(7). The trouble with this argument will be that the SEC has allowed proposals, such as restrictions on advertising by tobacco companies, when they raise social and ethical concerns.

Assume the SEC sided with the company. Many proponents would give up at this point, because they know that going to court will be an expensive proposition and the SEC’s support for the company will weigh heavily in the court’s analysis. Those who do go to court are likely to lose in short order for precisely that reason. Hence, having the SEC as a referee for the process offers an important gate-keeping function.

Now suppose Bebchuk’s amendment passes. The Ave Maria funds make their proposal. The company argues that the fund’s proposal is not “a proper action for stockholders under state law,” as required by Bebchuk’s amendment, because the director primacy rules inherent in section 141 trump the bylaw rights under section 109. The company further argues that the proposal relates “to the Corporation’s ordinary business operations.” Finally, the board of directors, in the exercise of its fiduciary duties, decides that the proposal is such a bad idea it should not be put to a vote. (BTW, does the proposal as written contain an adequate fiduciary out? The relevant language would seem to be “to the extent permitted by law” rather than “to the extent consistent with its fiduciary duties,” because the latter appears to modify only the initial issue of whether the amendment to the articles should go forward. A question for another day.)

The proponents argue that the terms “proper subject” and “ordinary business” can be interpreted in light of Rule 14a-8 precedents, since the Rule has very similar exclusions. They rely on cases like Lovenheim and Dole, to argue that proposals with ethical and social significance are a “proper subject” and rise above “ordinary business.”

Who referees the dispute? Does Bebchuk’s proposal allow shareholders to bypass Rule 14a-8 and thereby oust the SEC as referee? As I understand it, the answer is yes.

So if the company excludes the proposal, the proponent(s) will sue. What standard of review applies? Business judgment rule or, because it affects the franchise, Blasius? How much will the litigation cost the company? How long will the litigation take? Under the law in Delaware, shareholders can ask the Chancery Court to order a company to hold an annual shareholders meeting if more than 13 months have passed since the last one. But what if the litigation is preventing the company from completing a definitive proxy statement to solicit shareholders?

How much money, time, and effort will be soaked up to deal with a special interest proposal with almost no chance of passing?

Before you tell me this is a bogus problem, reflect on the long history of social activists using shareholder proposals to advance their pet causes even though the proposals routinely went down to defeat. Bebchuk’s proposal will simply encourage this sort of thing.

Alternatively, what if the shareholder/proponent is using a proposal to pursue some sort of private rent-seeking. In my article, Director Primacy and Shareholder Disempowerment and my book The New Corporate Governance in Theory and Practice, I explored that issue, arguing that union and state and local pension funds are both the most active institutions with respect to corporate governance issues and also the institutions most likely to use their position to self-deal—i.e., to take a non-pro rata share of the firms assets and earnings—or to otherwise reap private benefits not shared with other investors. With respect to union and public pension fund sponsorship of shareholder proposals under existing law, Roberta Romano observes that:

It is quite probable that private benefits accrue to some investors from sponsoring at least some shareholder proposals. The disparity in identity of sponsors—the predominance of public and union funds, which, in contrast to private sector funds, are not in competition for investor dollars—is strongly suggestive of their presence. Examples of potential benefits which would be disproportionately of interest to proposal sponsors are progress on labor rights desired by union fund managers and enhanced political reputations for public pension fund managers, as well as advancements in personal employment. … Because such career concerns—enhancement of political reputations or subsequent employment opportunities—do not provide a commensurate benefit to private fund managers, we do not find them engaging in investor activism.

This is not just academic speculation. The pension fund of the union representing Safeway workers, for example, used its position as a Safeway shareholder in an attempt to oust directors who had stood up to the union in collective bargaining negotiations.  Nor is this an isolated example. Union pension funds tried to remove directors or top managers, or otherwise affect corporate policy, at over 200 corporations in 2004 alone.  Union pension funds reportedly have also tried shareholder proposals to obtain employee benefits they couldn’t get through bargaining. 

Bebchuk elsewhere has dismissed such concerns as unwarranted, claiming that “a shareholder-initiated proposal for a change that would likely be value-decreasing would be highly unlikely to obtain majority support” and that a shareholder therefore could not use such a proposal to “blackmail management.” In still other work, however, Bebchuk has claimed that because members of the board of directors own such a small percentage of the stock of the company they will agree to value-reducing executive pay packages because the private benefits they reap from remaining in control exceed the lost value of their stock.  I’m skeptical of the merits of that argument, but if it is true of executive compensation, wouldn’t it also be true of value-decreasing shareholder proposals? Indeed, he claims that empowering shareholders will produce “benefits in large part by influencing management’s behavior rather than by leading to actual interventions.”

Granted, Bebchuk seemingly anticipates this argument by suggesting that these indirect benefits accrue only when managers expect a proposal to pass a shareholder vote.  Accordingly, the majority vote rule ensures that managers will not be subject to blackmail by a rent-seeking proposal advanced by an institution seeking private benefits because management knows such a proposal will not pass. There are several reasons, however, to believe that Bebchuk over-estimates the extent to which the majority vote requirement insulates the board and management from being blackmailed.

In the first place, people who are risk averse by definition will seek to avoid a loss even if the event in question has a positive expected value. As Bebchuk puts it, managers “prefer not to lose votes” and, as he has put it elsewhere, “managers are risk-averse.” Accordingly, managers may still give in to blackmail even where an objective analysis suggests the proposal has little chance of passage.

Second, there are several situations in which a rent-seeking proposal plausibly could threaten to achieve majority support. The rent seeking institution might propose a value-increasing change, for example, which it will agree to drop in exchange for some private benefit.  Bebchuk concedes this possibility, but dismisses it on grounds that “a blackmail argument can be made not only against increasing shareholders’ power, but also against maintaining the power that shareholders currently have,” which no one proposes reducing on this account.  It’s not clear, however, why the absence of proposals to further disempower shareholders necessarily provides a case for granting them extensive new powers. His argument also seems inconsistent with his claim elsewhere in the article that it is “not the case” that the “shareholder veto can ensure decisions regarding basic governance arrangements will be made in the interests of shareholders.”

Alternatively, an institution seeking private benefits could bundle a value-increasing and value-decreasing proposal in hopes of increasing the prospects of passage.  The institution also might offer side payments to other institutions.  In lieu of side payments, the institution might seek to assemble a coalition of other institutions that would also receive private benefits, which is perhaps the most likely scenario in which an investor coalition would coalesce.

Accordingly, the majority vote requirement is an inadequate constraint on rent seeking by union and public pension funds (or other institutional investors, such as hedge funds, for that matter). To be sure, like any other agency cost, the risk that management will be willing to pay private benefits to an institutional investors is a necessary consequence of vesting discretionary authority in the board and the officers. It does not compel the conclusion that we ought to limit the board’s power. It does, however, suggest that we ought not give investors even greater leverage to extract such benefits by further empowering them.

Cutting back on 14a-8

Larry Ribstein uses Lucian Bebchuk’s latest shareholder proposal as a starting point for a federalism-based critique of Rule 14a-8, concluding: “revise 14a-8 so that it just requires disclosure of agenda items permitted by state law.” Exactly.

Bebchuk: Gadfly?

Gordon Smith blogs on a shareholder proposal Lucian Bebchuk has put forward at Electronic Arts. I’ll blog on the substance of the proposal later. In the meanwhile, I want to cherry pick this line out of Gordon’s post:

Yes, gadfly shareholders can impose costs on firms, but we have developed various procedural protections to address those sorts of proposals. Serious governance proposals deserve to be heard and debated among shareholders, and the SEC should try to facilitate that outcome.

But this raises a question that can no longer lurk under the surface; namely, has Bebchuk become a shareholder gadfly? As I have argued in detail elsewhere, I’m convinced that Lucian is wrong about executive compensation, wrong about competitive federalism, and wrong about the respective roles of shareholders and directors. I don’t know what motives Lucian’s shareholder proposal campaign, but I am confident that it’s not enhancing American corporate law or governance.

Bebchuk’s crusade might be a good idea if you think, as Gordon wrote, that “shareholders have the potential to play an important role in the corporate governance system.” If you don’t, however, you’ll view all of this as gadflyism, at best. And, of course, I believe shareholders neither “have the potential to play an important role in the corporate governance system” nor, if they did, ought to be allowed to do so. As I’ve written before:

The core principle of corproate law is the separation of control from ownership of the residual claim (see, e.g., my The Case for Limited Shareholder Voting Rights). Given that activist investors tend to exhibit private rent-seeking behavior, collective action problems, rational apathy, and the like, there’s no reason to think empowering shareholders will improve corproate governance; indeed, to the conrary, there is every reason to think empowering shareholders would have pernicious effects (see my Shareholder Activism and Institutional Investors).

Even if you believe some shareholder empowerment relative to the present situation under Delaware corporation would be appropriate (my condolences on being so fundamentally misguided, BTW), how much is enough? Even a shareholder advocate like Fortune’s Geoff Colvin says he “isn’t sure about” Bebchuk’s latest pet project (the Say on Pay bill...). At what point does shareholder empowerment morph into shareholder micromanagement? And while the advocates of shareholder empowerment stop before reaching that line? Personally, my guess is that they’ll blow past it sort of the way I blow past speed limit signs.

iPod Confessions

Our friend and fellow corporate law professor Gordon Smith makes a surprising admission:

On Labor Day our family staged a 50-mile bicycle ride to support my 12-year-old sons in their quest to earn the cycling merit badge. The ride was particularly rough on one of the boys, who had a mountain bike. (The other had the foresight to borrow his friend’s road bike, and he was fine.) In an effort to distract my suffering son, I offered my iPod. Unfortunately, I have no music on my iPod, except whatever theme songs accompany my podcasts.

No music!? [That was my oldest daughter, who was incredulous.] Why have an iPod at all if you don’t listen to music on it?

I listen to podcasts, I told her. Notice that this product is made expressly for iPods.

He goes on to list the contents of his iPod. Mostly news and business, with what I guess is some high culture stuff mixed in.

I must confess to sharing Gordon’s daughter’s incredulity. I knew Gordon to be a serious guy, with strong credentials as an intellectual, but who knew he was such an egg head? 

OTOH, perhaps Gordon agrees with Camille Paglia that:

Popular culture is the new Babylon, into which so much art and intellect now flow. It is our imperial sex theater, supreme temple of the western eye. We live in the age of idols. The pagan past, never dead, flames again in our mystic hierarchies of stardom.

If so, as one person of faith to another, kudos to Gordon for opting out. As for me, however, I guess I’m a pagan when it comes to pop culture. I have no podcasts—zero, nada, zilch—on my iPod. Instead, it’s all music, music videos, and TV shows. FWIW, here’s the top 10 most frequently played items on my iPod:

• Last to Die—Bruce Springsteen


• Layla—Eric Clapton


• Land of Confusion—Genesis


• Badge (live)—Eric Clapton


• Won’t Get Fooled Again—The Who


• Where the Streets Have no Name—U2


• All Along the Watchtower—Jimi Hendrix


• Jungleland (live)—Bruce Springsteen


• Bonny Portmore—Loreena McKennitt


• Variations on Clair de Lune—Alex Grassi

Anybody else want to ‘fess up as we separate the intellectuals from us regular folks? 

PS: If you’re an intellectual or, at least, a non-pagan, please buy my books anyway, okay?

Washington DC Event: Stockholders at the Wheel: Shareholder Access Rule

Stockholders at the Wheel: Shareholder Access Rule

Federalist Society Corporations, Securities, and Antitrust Practice Group

Tuesday, September 23, 2008 12:00 PM - 2:00 PM

National Press Club
529 14th St. NW
13th Floor
Washington, DC 20045

On November 28, 2007, the Securities and Exchange Commission voted to adopt an amendment to Rule 14a-8(i)(8), codifying the commission’s long-standing interpretation that a company may exclude from its proxy materials shareholder proposals relating to making or opposing a director nomination or to setting up a process that would allow shareholders to conduct an election contest in the future by requiring the company to include director nominations from shareholders in the company’s own proxy materials.

In their 2006 decision of AFSCME v. AIG, the Second Circuit declined to defer to the Commission’s interpretation of Rule 14a-8(i)(8), requiring AIG to include a proposal from AFSCME in its proxy materials that would amend AIG’s bylaws to allow shareholders to include nominations of individuals for election as directors in subsequent proxy materials. The SEC’s amendment codifies the position it has taken on an individual basis in no-action and interpretive letters.  Chairman Cox further stated that the Commission could “re-open this discussion in 2008 to consider how to strengthen the proxy rules to better vindicate the fundamental state law rights of shareholders to elect directors.”

The question of shareholder access to proxy materials implicates important values on both sides of a continuing controversy. Permitting access to the company’s proxy materials would facilitate the right of shareholders to nominate and elect directors, while rendering infeasible the existing proxy rules’ requirement of full disclosure.

Featuring:

Prof. Stephen Bainbridge, UCLA School of Law
Mr. Damon A. Silvers, American Federation of Labor and Congress of Industrial Organizations
Mr. John Olson, Gibson Dunn & Crutcher LLP
Hon. E. Norman Veasey, Weil, Gotshal & Manges
Moderator: Hon. Brett Kavanaugh, United States Court of Appeals for the D.C. Circuit

Registration details: http://www.fed-soc.org/events/eventid.683/event_detail.asp

Lunch will be served.
There is no charge to attend this event. 

Up to 1.5 hours CLE credit available.
CLE credits $20.

Is Omnicare Really of “Questionable Continued Vitality”?

Dale Oesterle:

The Omnicare case is of “questionable continued vitality” notes a new opinion from the Delaware Chancery Court.  In Optima v WCI Steel, the Chancery Court refused to apply Omnicare to block a deal between Severstal and WCI in the face of a higher bid from Optima.  The WCI union, interpreting a collective bargaining clause to give them veto power over any acquisition, sided with Severstal.  The Court held that the provision, imposed by a bankruptcy court and not the board, was not a deal protection device.  It also held that a requirement of a written consent vote by shareholders 24 hours after the merger was signed was not a deal protection device either but simply a ratification timing requirement.  The holding that Omnicare does not require a “fiduciary out” clause after the vote to enable the target to accept other offers surprised some, but not I.  The right to terminate a merger after a shareholder vote must itself be preserved in the merger agreement (See Section 251(d)) and is and always has been optional.  The case is notable because of dicta on the “questionable continued vitality” of Omnicare, a decision that was poorly reasoned on its facts and has caused trouble ever since its promulgation.  The Supreme Court, at some point, will have to grapple with setting sensible limits on a board’s ability to bind the firm in merger negotiations.

Indeed. Unfortunately, Omnicare is merely the worst offender of all too many Delaware decisions that unjustifiably call into question the validity of precommitment strategies adopted by a board of directors. As I argued in my article, Dead Hand and No Hand Pills: Precommitment Strategies in Corporate Law:

Corporations frequently make use of precommitment strategies. Examples include such widely used devices as negative pledge covenants and change of control clauses in bond indentures, fair price shark repellents, no shop and other exclusivity provisions in merger agreements, mandatory indemnification bylaws, and so on. This paper argues that poison pills also can be understood as a form of precommitment, by which the board of directors commits to a policy intended either to negotiate a high acquisition price or to maintain the corporation’s independence.

In Quickturn Design Sys., Inc. v. Mentor Graphics Corp., the Delaware supreme court invalidated a no hand poison pill on grounds that a board of directors lacks authority to adopt such devices. In doing so, the court misinterpreted relevant Delaware law. It unjustifiably called into question the validity of a host of corporate precommitment strategies. Finally, and perhaps most troublingly, it called into question the central tenet of Delaware corporate law; namely, the plenary authority of the board of directors.

This article argues that the Delaware supreme court’s decision was wrong both as a doctrinal and a policy matter. There simply is no firebreak between the sorts of board self-disablement deemed invalid by Quickturn and the host of other precommitment strategies routinely used by corporate boards of directors. The Delaware supreme court’s conclusion that the former are invalid for lack of statutory authority thus threatens to invalidate all of the latter. The article concludes by arguing that the Delaware supreme court should have analyzed the no hand pill under standard fiduciary duty principles rather than creating a new prophylactic ban on precommitment strategies.

Law Professor Salaries

I spent the last couple of days in Chicago at my first meeting as a member of the ABA Committee on Corporate Laws. I expect to blog regularly on issues that come up before us. In the meanwhile, however, I want to pass on a juicy bit of gossip I heard at the meeting. Allegedly, there is a certain Harvard law professor (well known to regular readers of this blog as one of my bête noires) who has been offered $600,000 per year by Yale. Wow.

It got me to wondering: What’s the highest pay any US law professor gets? And why aren’t I getting it? Answers to the first question are welcome. Answers to the second will be ruthlessly deleted unless they are exceptionally flattering.

BusinessAssociationsBlog.com: A 99.9% Politics Free Zone

Dave Hoffman has a (typically) provocative post, in which he argues that:

It’s the news-hook that launched a thousand nominally law-related blog posts: the presidential election season! Surfing the vast blawgosphere tonight, it feels like every other post, on every other blog written by, and often for, law professors, is about the federal presidential election process. This, despite the often-advanced (in quieter times) view that the Supreme Court (the motivating issue for many posts) has little substantive impact on the issues that most Americans care about, despite a recent emphasis by progressive scholars on direct democracy and regional and state-led legal reform, and (sadly) the truth that law professors only rarely have novel or interesting insights about Presidential politics. (Bill Stuntz is an exception to this and many other rules).

It is particularly dispiriting that the election season threatens to make unreadable some of my favorite blogs, which now seem to be given over almost entirely to hashing of the latest scandal, speech, purported policy shift, or inside-politics joke. (I’d link, but I like some of these folks when they aren’t dressing up as Bill Kristol or James Carville!)

Dave’s rant is highly relevant to the motivation behind the current (and, presumably, permanent) structure of ProfessorBainbridge.com. I love blogging. It’s become a remarkably fun hobby. But I don’t think very many people, if any, share my eclectic set of interests in corporate law, wine/cooking, and the worlds of politics, religion, culture, and football. So I created three distinct blogs, each of which was intended to appeal to a very different audience. On the off chance that some folks would, in fact, share my odd mix of interests, I also created a portal page that offers a link to all three.

I’ve discovered I need a space to dress up (as Dave puts it) as Robert Parker and a space to dress up as Bill Kristol or James Carville. But I also don’t want to lose corporate law teachers like Dave as potential readers. In particular, I’ve found that I often have ideas about corporate law that would be of no interest to a general reader, but which my fellow corporate law academics (and, maybe even more important, the Delaware judiciary) might find of interest. I wanted to give those ideas a forum that would be a safe place even for the most die hard Obama fan in my readership.

Hence, this blog has been and will always remain a 99.9% politics free space. Short of becoming a meek and mild law-only blogger, which I’m unwilling to do, it’s the best I can do. So please keep reading (and buying my books!).