Last week, Vice Chancellor Laster denied a motion to dismiss a lawsuit against the board and controlling stockholder of TripAdvisor, which challenged the board’s decision to reincorporate from Delaware to Nevada. A lot of corporate governance folks have been closely watching this case in light of recent public comments about moving out of the state. Delaware has long been known as the premier and most reliable place to incorporate a company, but lately there’s a view that it’s been too easy for plaintiffs to pursue claims for breaches of fiduciary duty.
In the 52-page opinion, VC Laster applied the “entire fairness” standard to this fact pattern, which involved a controlling stockholder. This Wilson Sonsini memo summarizes the background and key points from the decision:
The essence of the court’s determination was that the purpose of the reincorporation was to reduce stockholder litigation risks for its fiduciaries and that a reduction in the litigation rights of stockholders in a controlled company creates a non-ratable benefit for the controller. Accordingly, the standard of review governing the transaction is entire fairness unless the company uses some type of procedural protections, such as approval by an independent board committee and/or minority stockholders, to lower the standard of review by simulating an arm’s-length negotiation. Because no such steps were taken here, the court denied the defendants’ motion to dismiss and allowed the case to proceed under the entire fairness standard.
A management presentation and the proxy statement for the reincorporation proposal indicated that one purpose would be to provide greater liability protection for fiduciaries, based on a comparison of Nevada and Delaware law. According to the opinion, the disinterested stockholders didn’t seem to be on board:
At stockholder meetings in June 2023, holders of a majority of the voting power at each company approved each conversion. Assuming Holdings cast all of its votes in favor the Company conversion, only 5.4% of the unaffiliated Company stockholders voted in favor. Assuming Maffei cast all of his votes in favor of the Holdings conversion, only 30.4% of the unaffiliated Holdings stockholders voted in favor. Holdings and Maffei thus provided the decisive votes.
Tulane Law Prof Ann Lipton pointed out that the materiality of the litigation risk was an important part of the decision:
But here’s the thing. To get there, he had to distinguish some prior cases that concluded that the elimination of litigation rights did not state a claim for breach of fiduciary duty. This issue had come up, for example, in the context of charter amendments adding an exculpation clause under Section 102(b)(7), and in a reincorporation to California. VC Laster was pretty clear that he simply thought some of them were wrongly decided, but his main point was that in those cases, the amendments were immaterial – i.e., it was not clear that the change conferred a non-ratable benefit on existing directors. By contrast, he held, in this case, the differences between Nevada law and Delaware law are sufficiently plain – and the controller’s reasons for wanting the move sufficiently blatant – that the stockholder plaintiffs had at least, for pleading purposes, established they were losing a valuable right.
VC Laster was careful to note that the outcome resulted from this being a controller transaction. He called out that the decision would be different for a company without a controlling stockholder or for a company that had conditioned the transaction on procedural protections. In addition, he made a point of stating that if the plaintiffs are successful on the merits, the remedy would be damages based on the value of the stockholders’ “fundamental right” to litigate, rather than enjoining the move, which is what the plaintiffs had requested. So, companies are still free to leave Delaware – they just might have to pay their stockholders to do so, if there are conflicts and the transaction isn’t “cleansed” or entirely fair. Here’s an excerpt from the opinion about how that award could be calculated:
The Company’s stock has a trading price. In the conversion, nothing will change except the Company’s corporate domicile. Maffei’s control will remain constant. The Company’s business will remain constant. The only independent variable is the law governing its internal affairs.
Given that set-up, the change in the Company’s trading price should help quantify the harm, if any, caused by the conversion. As long as the market for the Company’s common stock is semi-strong-form efficient, then the price reaction should be indicative. Note that the stock price need not fairly approximate a pro rata share of the Company’s intrinsic value for the price reaction to matter. As long as any pricing disconnects remains consistent across variables other than the governing law, the price impact should provide insight.
Where do we go from here? The analysis in this opinion is relevant for moves to any other state, not just Nevada. That means that you can’t give short shrift to the process for approving reincorporation decisions – particularly if a controlling stockholder is involved.
We’ve posted the transcript for our latest “Activist Profiles & Playbooks” webcast. Our panelists — Juan Bonifacino of Spotlight Advisors, Anne Chapman of Joele Frank, Sydney Isaacs of H/Advisors Abernathy and Geoffrey Weinberg of Morrow Sodali — discussed lessons from 2023, the evolution of activist strategies, UPC, what to expect from activists in 2024 and how to prepare.
Here’s a snippet of Juan’s comments on the flip side of UPC for activists:
It may be harder for dissidents to get larger slates elected because each candidate needs to be differentiated. Before, an activist could put up a slate of four or five people and because someone’s voting on your card, that ends up depriving the management slate from getting votes. Now people are saying, “Why did you nominate three instead of two? What does this third person add?”
In terms of whether that’s a higher bar, it requires a more nuanced argument that the dissident needs to make to say, “This solution to this problem I’ve identified needs these three people and this is why” in a way that maybe wasn’t as central historically. It was getting there, if you look over the last 10 years, but again, universal proxy accelerates that trend.
Members of this site or of DealLawyers.com can access the transcript of this program. If you are not a member, email sales@ccrcorp.com to sign up today and get access to the full transcript – or sign up online.
A federal district court has ruled in favor of ISS in its lawsuit challenging the SEC’s 2020 rule that would have subjected proxy advisors to enhanced regulations by saying they engage in the “solicitation” of proxies. Bloomberg reported on the decision, and summarized it as follows:
The Securities and Exchange Commission “acted contrary to law and in excess of statutory authority when it amended the proxy rules’ definition of ‘solicit’ and ‘solicitation’ to include proxy voting advice for a fee,” Judge Amit P. Mehta said Feb. 23 for the US District Court for the District of Columbia. A 2022 SEC repeal of some proxy firm requirements under the rule was insufficient, he said.
It would be a vast understatement to say that proxy voting advice is a complex topic with longstanding issues (and some “bad blood”). The case that ISS just won relates all the way back to a suit that it first filed in response to Commission-level guidance that was issued in 2019, and that continued when the SEC adopted rules in 2020. Those multi-part rules would have required proxy advisors to make extra disclosures and allow companies to respond to their voting recommendations. The 2020 rules were celebrated by companies, which is why the SEC didn’t make many friends when it tried to repeal some of them in 2022. That partial repeal also obviously didn’t win over ISS, which continued with this lawsuit.
As noted by Bloomberg, ISS’s victory is disappointing news to companies and trade organizations – which are in the midst of their own challenges to the Commission’s 2022 repeal that is mentioned above. They want the 2020 rule that just got vacated to be fully back in place and are fighting that out in federal appeals courts.
The court opinion is a real treat for securities law history buffs, walking through the regulation of proxy solicitations from 1956 forward. Here’s how it describes some of the many “twists & turns” that led to the SEC getting sued by both sides:
In November 2021, the SEC announced that it had concluded its review of the Final Rule. It proposed rescinding two of the three new conditions that, if satisfied, would exempt proxy voting advice from Rule 14(a) ‘s information and filing requirements. Proxy Voting Advice, 86 Fed. Reg. 67383 , 67387 (Nov. 26, 2021). Specifically, the SEC proposed eliminating the requirements that proxy advisory firms disclose their advice to corporate issuers and provide their clients with the issuers’ responses. Id. at 67388. The conflict-of-interests disclosure condition would remain, however. Id. The agency also proposed removing the Note amendment to the anti-fraud provision, Rule 14a-9 . Id. at 67390.
Importantly, the agency did not change its position that proxy voting advice for a fee constituted “solicitation,” and it therefore left that definitional amendment unchanged. Id. at 67384. In light of ongoing rulemaking, and at the parties’ request, the court agreed to continue to hold the case “in abeyance until the earlier of March 31, 2022, or the promulgation of final rule amendments addressing proxy voting advice.” Order Granting Defs.’ Mot. to Continue Abeyance, ECF No. 58.
By the end of March 2022, the agency had not yet completed the rulemaking process and again sought to continue this matter. [*8] Defs.’ Status Report and Mot. to Continue Abeyance, ECF No. 61. This time, however, Plaintiff opposed the agency’s request. Pl.’s Opp’n to Defs.’ Mot. to Continue Abeyance, ECF No. 62. The court agreed with Plaintiff, ruling that because the SEC had not proposed to withdraw proxy voting advice from the amended definition of “solicit” and “solicitation,” the case should move forward as to the claims challenging the definitional amendment. Minute Order, Apr. 17, 2022.
On July 13, 2022, the Commission adopted a final rule that rescinded the two conditions the agency had proposed to excise in November 2021. Proxy Voting Advice, 87 Fed. Reg. 43168 (July 19, 2022) (“Amended Final Rule”). The Amended Final Rule rendered moot Count V of the Amended Complaint (the First Amendment claim) and Count III of the Amended Complaint (the Proxy Guidance challenge) to the extent those claims covered the rescinded provisions.
The opinion goes on to devote many paragraphs to the meaning of the word “solicit” – sidestepping the current Chevron debate. Here’s the conclusion:
In sum, the court holds, at Chevron step one, the ordinary meaning of “solicit” at the time of Section 14(a) ‘s enactment does not reach proxy voting advice for a fee. Nor does the Exchange Act ‘s history and purpose support the SEC’s reading. The court therefore has no cause to move to Chevron step two and afford deference to the agency’s position.
By defining the terms “solicit” and “solicitation” in the proxy rules to include proxy voting advice for a fee, see 17 C.F.R. § 240.14a-1(l)(1)(iii)(A) , the SEC acted contrary to law and in excess of statutory authority, [*21] 5 U.S.C. § 706(2)(A) , (C) . Accordingly, the court grants summary judgment in favor of Plaintiff as to Counts I and II, denies the SEC’s and NAM’s cross-motions, and vacates the definitional amendment codified at 17 C.F.R. § 240.14a-1(l)(1)(iii)(A) . See 5 U.S.C. § 706(2)(C) (stating that courts must “set aside agency action” if found to be “in excess of statutory jurisdiction, authority, or limitations, or short of statutory right”).
The National Association of Manufacturers is considering an appeal of this decision. In the absence of a higher-level authority stepping in, it will be quite the puzzle during proxy season if one circuit says that the SEC had no business regulating proxy advisors and another circuit ends up saying that those same rules need to get reinstated.
Yesterday, the PCAOB announced that it will hold a virtual roundtable about its hotly contested proposal to enhance auditor responsibility for considering non-compliance with laws and regulations. The roundtable is next Wednesday, March 6th, at 9:30 a.m. Eastern.
In light of the roundtable, the PCAOB has also reopened the comment period for this proposal – until Monday, March 18th. The previous comment period closed last August. There was no shortage of feedback. All of the letters are available on the PCAOB’s website – and Meredith most recently shared notable themes a few months ago.
The PCAOB has a list of topics that it is considering more closely. Here’s more detail:
The roundtable will include three panels focused on the proposal’s requirements relating to auditors’ identification of laws and regulations and assessment of those laws and regulations, as well as costs and benefits of the proposal.
Commenters are encouraged to specifically consider the questions and topics included in the roundtable briefing paper, and commenters are welcome to address any aspect of the proposal. Commenters are asked to provide reasoning and relevant data supporting their views.
Check out their announcement for instructions on joining the roundtable.
Check out John’s latest “Timely Takes” Podcast featuring Orrick’s J.T. Ho & his monthly update on securities & governance developments. In this installment, J.T. reviews:
1. Trends in Advance Notice Bylaw Litigation
2. Contested Election Comment Letter Trends
3. Technical Amendments to Corp Fin’s Confidential Treatment Application Guidance
4. Pay versus Performance Update for 2024
5. Tornetta v. Musk Decision
As always, if you have insights on a securities law, capital markets or corporate governance issue, trend or development that you’d like to share in a podcast, we’d love to hear from you. You can email John and/or Meredith at john@thecorporatecounsel.net or mervine@ccrcorp.com.
The rumor mill cranked into high gear last week for the SEC’s final climate disclosure rule – with many outlets – including Politico and Forbes – reporting that the final rules are being internally circulated. Here’s an excerpt from the Forbes article:
According to Declan Harty of Politico, the final draft of the proposal is currently being circulated to commissioners for their consideration. If his sources are correct, this indicates that a vote will take place during the first quarter, probably sometime in March.
A rule adopted in 2024 will go into effect in 2026, which aligns with other global developments in this area including the European Union’s European Sustainability Reporting Standards. Domestically, California is developing their own reporting standards utilizing the same timeline.
However, the passage by the SEC will not be the final word in this development. Expect the Republican controlled House of Representatives to utilize their oversight authority to revoke the rule. The timing of that action will most likely be tied to the 2024 elections, and the likelihood that Republicans maintain control of Congress and gain control of the White House. With the rule not going into effect for almost two years, Congress can wait until after the election to override the rule. If they act now, President Biden will most likely veto, as he did when Congress overrode the Department of Labor rule allowing ESG considerations in retirement plans.
The article notes that we can also expect legal challenges if and when the rule is adopted. The Commission is well aware of that and will be working to ensure that the final release can be solidly defended against those attacks.
So far, the SEC hasn’t announced an open meeting to vote on this matter – but a lot of folks are sure to be watching for an announcement. Many had already been wagering on early March due to the Congressional Review Act and the SEC’s Reg Flex Agenda. But keep in mind that there could still be a lot to do behind the scenes even after a draft rule is circulated. When it comes to specific timing, we won’t know until we know!
Among the reports circulating last week about the SEC’s climate disclosure rule were a few – e.g., from Reuters and the WSJ – that the draft that is being internally circulated does not include a reporting requirement for Scope 3 emissions.
Eliminating the proposed “Scope 3” disclosure requirement would not be too surprising based on the comments that emphasized what a heavy lift this would be for private companies in the supply chain, the questions on whether there are reliable ways to collect & calculate these emissions, and the signals that major asset managers have been sending since the time the rules were proposed. But at many companies, “Scope 3” is the biggest part of their emissions. So, dropping that aspect of the rule would make a big difference in what’s reported – at least, in the US. Here’s more detail from Reuters:
If adopted, the new draft would represent a win for many corporations and their trade groups that lobbied to water down the rules. But it would also deviate from European Union rules which make Scope 3 disclosures mandatory for large companies starting this year and potentially complicate compliance for some global corporations.
The SEC’s original draft proposed mandatory disclosure of emissions for which companies are more directly responsible, dubbed Scope 1 and Scope 2. Some lobbyists pushed the SEC to require such disclosures only if they are material to a company’s business. Reuters could not ascertain whether the latest draft changed the Scope 1 and 2 requirement threshold.
See this blog from Cooley’s Cydney Posner for more detail on the back & forth on Scope 3. Stay tuned!
The SEC’s final rules on SPACs (and de-SPACs) – which were adopted almost exactly a month ago – have been published in the Federal Register. That means that the compliance date for most of the rules is July 1st of this year, and the compliance date for iXBRL tagging is June 30, 2025. The final rules will require additional disclosures in SPAC IPOs and de-SPAC transactions and heighten liability risks for those involved.
Of course, the rule also included guidance on “investment company” status, which is already in play. As I blogged last month, that aspect of the release – and the part about projections – is something that all companies should care about.
Securities lawyers aren’t exactly known to be “early adopters” of new technology. We tend to be skeptical. But the latest leap in “AI” capabilities is hard to ignore. This Gibson Dunn memo gives examples of how data analytics and artificial intelligence can make disclosure compliance work easier and better – and explains why you should get up to speed sooner rather than later. Here’s an excerpt:
There are several ways companies could use data analytics technology to assess and mitigate the risks posed by current and coming disclosure requirements. As an initial matter, companies could use some of the third-party tools described above to test their data and disclosures.[45]
Companies could use existing data sets of SEC comment letters and enforcement actions to develop their own lists of SEC hot topics and trends. Companies could use data analytics technology to compare the disclosures of peer companies and compare those disclosures against their own. This type of analysis could help companies identify whether peers are handling their disclosures differently and inform changes to their disclosures if the analysis identifies gaps. Especially in uncertain or new regulatory environments, such as the SEC’s new cybersecurity reporting rules and its proposed emissions reporting rules, evaluating and learning from the disclosures of peer firms is an important way to mitigate risk. Data analytics technology can make that process more efficient and dynamic.
Companies could also employ data analytics technology to learn from the mistakes peer companies have made with their disclosures. For example, companies could analyze SEC or Environmental Protection Agency (EPA) enforcement actions and identify the issues that triggered regulatory scrutiny. Data analytics technology could enable analysis of a vast number of relevant enforcement actions to discern key compliance errors or patterns of enforcement. Companies could also cross reference the disclosures of peer companies against SEC or EPA enforcement actions to identify which disclosures triggered investigation and enforcement.
Looking inward to the company’s own data, data analytics technology could be used to evaluate internal controls and monitor and analyze hotline or whistleblower complaints. Similarly, companies could employ data analytics technology to analyze their own historical disclosures and compare them against current enforcement priorities and new regulations to determine what the potential risks are and what, if any, sections of the disclosures need to be updated or modified.
The memo also shares ways that data analytics can be used to mitigate activism and litigation risks, address fraud and non-compliance, combat corporate misinformation, and more. The memo cautions that AI still has plenty of shortcomings and cannot be fully trusted. That said, regulators, activists, and plaintiffs are already using this technology – so companies (and their advisors!) will be at a disadvantage if they don’t understand its capabilities. I, for one, will be welcoming our robot overlords with open arms.
Earlier this week, the U.S. Chamber of Commerce announced that it had teamed up with other business organizations to file a lawsuit against the state of California over its new climate disclosure laws. Here’s what my colleague Zach Barlow shared about this development on PracticalESG.com (also see this WSJ article):
California Climate Disclosure Bills SB 253 and SB 261 are being challenged in a new lawsuit brought by the American Chamber of Commerce. The lawsuit argues that the bills are unconstitutional on two main grounds:
1. The laws violate the First Amendment by compelling speech.
2. The federal government preempts California through the Clean Air Act and the Dormant Commerce Clause.
“Both laws unconstitutionally compel speech in violation of the First Amendment and seek to regulate an area that is outside California’s jurisdiction and subject to exclusive federal control by virtue of the Clean Air Act and the federalism principles embodied in our federal Constitution. These laws stand in conflict with existing federal law and the Constitution’s delegation to Congress of the power to regulate interstate commerce. This Court should enjoin the Defendants from carrying out the State’s plan.”
This case is not only important to the California laws, but could also shed light on what a challenge to the SEC’s upcoming Climate Related Disclosures could look like. In a case against the SEC’s rule, compelled speech will certainly be raised as an issue and this case could give us an idea of how persuasive that argument will be for the courts. Additionally, point number 2 is likely to be inverted in a future SEC challenge. Instead of arguing that the state is preempted because the federal government has the sole power to regulate emissions, the argument could invoke the Major Questions Doctrine and argue that the SEC as a federal agency doesn’t have statutory authority to regulate emissions – an argument made in comments to the SEC proposal.
The arguments here are interesting and success on either point could mean the end of SB 253 and SB 261 and introduces more uncertainty about the future of the laws. In January, it was revealed that a budget shortfall would hamstring funding for the bills’ implementation. It’s unlikely that we’ll have concrete answers about the bills’ future anytime soon as the legal challenge will take time. Whatever the initial outcome, the losing party is likely to appeal.
