W I T N E S S E T H:

Forum Selection Bylaws Appeal Dropped

Exclusive forum bylaws are enforceable in Delaware, at least for now. That's because, as Fish & Richardson's Litigation Blog reported, the plaintiffs have apparently dismissed their appeal of the Chancery Court case that validated the bylaws, Boilermakers Local 154 Retirement Fund, et al. v. Chevron Corp. 

This is important news for Delaware companies because exclusive forum selection bylaws can help reduce the risk of simultaneous litigation in multiple forums and adoption of the bylaws doesn't require a shareholder vote. This means that a board can adopt the bylaws at a regular meeting, and there seems to be little reason not to do so. As a result, many, many companies are adopting these bylaws each week, and those Boards who haven't examined them yet should consider doing so at their next meeting.

You can find a blog post about Exemplify's standard forum selection bylaws here. Interestingly, although most companies have adopted bylaws very close to the Chevron or FedEx ones validated in the Boilermakers decision, Exemplify analysis suggests that the standard version is evolving. In particular most firms have not inadvertently copied the misspelled word Exemplify identified in the original Chevron bylaws, although about 10% have. 

SEC Proposes Pay Ratio Disclosure

On September 18 the Securities and Exchange Commission proposed rules to implement the "pay ratio disclosure" called for by the Dodd-Frank Act. The rules require publicly traded companies to identify (1) the median annual total compensation of all employees and (2) the median annual total compensation of Chief Executive Officer, and (3) for the benefit of those who haven't mastered the arcane art of division, the ratio of the two numbers. The rules, which are  pursuant to Section 953(b) of the Dodd-Frank Act of 2010, are implemented through an amendment to Item 402 of Regulation S-K.

The pay ratio disclosure rule is controversial. Prior to even proposing the rule, the SEC apparently had received over 22,000 comment letters plus a huge number of form letters. The proposed rule itself passed by only a 3-2 vote at the Commission level and totaled 162 pages of text. Yes, it took the Commission staff 162 pages to describe a ratio of two numbers.

Part of the reason the proposal is so lengthy is that the Commission staff is trying to be flexible on how companies implement it. The proposal would exempt "emerging growth companies," "smaller reporting companies," and foreign private issuers, and would allow statistical sampling and other methodological flexibility in making the median employee determination.

The likely reason the staff is trying to be flexible is that they themselves realize that the pay ratio disclosure wIll be costly for businesses and has little to do with investor protection. As Commissioner Michael Piwowar correctly noted, the proposal "unambiguously harms investors" and has no benefits that are within the SEC's mission. And Commissioner Daniel Gallagher pointed out that the SEC staff themselves were unable to identify any benefits from the proposed rule.

So who is in favor of the proposal? Commissioner Luis Aguilar argued that the disclosure of the pay ratio is necessary because "investors are asking if such a high level of CEO-pay multiples is in the interest of corporations and their shareholders." But of course investors as investors are asking no such question. Investors may well believe executive compensation is too high, but that information is already disclosed in excruciating detail under existing rules. The only new piece of information is the determination of the "median" employee, and this is the most costly and irrelevant aspect of the rule. Imagine a large corporation with many subisidiaries, each with its own mix of part-time, seasonal, offshore, and other employees making such a calculation. How is a large company supposed to make that calculation at reasonable cost, and who cares? The most likely scenario is that companies will waste large sums of money attempting to comply with the requirement and investors will pay no attention to the disclosure. 

Aguilar cites only three agenda-driven social activist funds who are purportedly "asking" for the disclosure, along with the AFL-CIO (see footnote 3). Indeed, the most vocal supporter of the rules seems to be Richard Trumka, the head of the AFL-CIO. I think it's beyond question that the AFL-CIO may have overriding objectives other than investor protection.

The pay ratio disclosure may, somewhat ironically, work against the labor interests that pressed it so strongly. The disclosure will not reveal anything about overpaid executives (as that is already disclosed), but it may reveal something about overpaid rank-and-file employees. If employees are being overcompensated, one might actually see hostile bidders and activist hedge funds using this information to agitate for a takeover and mass layoffs. So the labor push to calculate this information could actually work against employee interests.

In a sense, the SEC had little choice but to issue pay-ratio rules because Dodd-Frank required this disclosure. However, the SEC has authority to create safe harbors from disclosure rules, and the SEC should do everything possible to minimize the impact on the economy. In particular, the best solution would be for the SEC to create a safe harbor for companies that estimate the pay gap between CEO and median employee on the high side or within a range. That would serve the objectives of the Dodd-Frank Act that assume is that a large gap is a bad thing, while not requiring companies to calculate the exact numbers. Or, alternatively, the Commission could only require disclosure of the ratio only if material to investors, but I won't hold my breath for that.

Standardizing Forum Selection Bylaws

The corporate law community is abuzz right now with talk about forum selection bylaws in the wake of the Delaware Chancery Court's decision in Boilermakers Local 154 Retirement Fund v. Chevron Corp. I have a post over at the Exemplify blog that shows the most standard version of forum selection bylaws currently prevailing in the market, derived using Exemplify. For those who haven't seen it, Exemplify is a brand-new service designed for transactional lawyers that synthesizes market standard language for any deal document from a comprehensive, word-for-word analysis of all of EDGAR. If you are advising clients on adopting forum selection bylaws you don't want to miss the post, as it gives the most standard text for forum selection bylaws/charter amendments together with a quick introduction to Exemplify's technology. Disclosure: I am affiliated with Exemplify.

An Autopsy of the Hess Proxy Results

The contentious proxy battle between Hess Corp. and Elliott Associates concluded a little over a week ago with a negotiated settlement. The proxy contest was notable, among other things, for the large number of corporate law professors who weighed in on either side of the contest. Hess settled with Elliott on the eve of the stockholder meeting with an agreement to elect all the management nominees and to add three of Elliott's nominees. But what would have happened if the parties hadn't settled?

Who Would Have Won?

We would expect to find the answer in the Form 8-K filed by Hess to disclose the preliminary voting results. The reported results are set forth in the following table: 

The typical reader would likely conclude from this disclosure that management nominees had received overwhelming support. After all, the vote "for" those nominees far exceeded the "withheld" vote for by a wide margin. The highest vote-getter from the management nominees received 135,282,170 votes "for" and only 2,369,213 "withheld," or about 98% voted in favor. The lowest vote-getter received about 97% voted in favor. The table looks like a pretty resounding vindication of management.

In fact, the actual results were quite the opposite. The problem is that the tabulation of the votes for each director is missing about 145 million shares. One can see this by comparing the total vote on each director above with the total vote on the proposal to declassify the Board, as set forth below:

For this proposal, approximately 282 millon votes were cast, compared to the 138 million or so cast on each management nominee. What happened to the other approximately 145 million votes missing from the director tallies?

The answer is that the "missing" shares were those owned by shareholders who returned the Elliott proxy card rather than the management proxy card. The votes for Elliott's nominees didn't show up because Elliott withdrew its nominees pursuant to the settlement. If Elliott hadn't withdrawn its nominees, they would have appeared in the first table above, and they likely would have received more votes than any of the management nominees. Thus, contrary to what one would conclude from the Elliott disclosure, the management nominees actually garnered relatively little support from disinterested stockholders.

How Close Was the Vote?

How much support did the management nominees receive from non-management shareholders? On first glance, even adding back in the missing vote information, one might think the vote was fairly close. After all, we're talking about 135 million or so votes for the management nominees and perhaps 145 million for the Elliott nominees. But that would ignore the fact that Hess officers and directors owned about 10% of the outstanding common stock, and it seems safe to assume they voted for their own nominees. Thus, the incumbents really only received fewer than 100 million of the non-managment votes compared to over 145 million for Elliott's nominees. That's a drubbing, not a close vote.

Withheld Authority or Withheld Facts?

Is the Hess disclosure accurate? Yes and no. The withhold vote totals themselves are arguably technically correct. Even though 145 million other shares voted for nominees other than the managment nominees, the votes were not registered as "withheld" votes from management nominees because Elliott's proxy card did not provide a space to withhold votes from management's nominees. As is typical in a proxy contest, management's nominees are not listed on the dissident's card, just as the dissident's nominees are not listed on management's card. Thus, owners of those 145 million shares did not check a box to withhold authority to vote for management's nominees; they just voted for other nominees.

On the other hand, it should be obvious that shareholders who voted for Elliott's nominees were withholding authority to vote for the management nominees who were running against them. Proxies are not really votes; they are simply agency appointments to cast votes. Checking "withhold authority" is just a restriction on an agency power otherwise given to vote the shares.  It authorizes the proxy holder to appear at the meeting and vote, just not for the nominees from whom authority was withheld. This is exactly the same situation as a person who returned the Elliott card, who has given authority to vote "for" Elliott nominees, but has withheld authority to vote "for" the managment nominees.

The failure to include these votes as "withhold" from management nominees therefore completely disenfranchises those who voted for the Elliott nominees. They were deprived of the opportunity to vote "for" the Elliott candidates (because the nominees were withdrawn), and deprived of the opportunity to "withhold" from management candidates (because they weren't listed on the proxy card). Therefore, to report the "withheld" vote for Hess's nominees as a few million shares without further disclosure is misleading, because another 145 million shares were considered present at the meeting and "withheld" from those nominees. Let's hope that Hess will at least include a footnote explaining the real withhold vote in the final report of results.

The issue identified here is a problem with the mechanics of proxy contests that settle late in the process. On a going-forward basis, the SEC should clarify that the "withheld" votes for nominees include votes on a proxy card that doesn't include those candidates' names. In the mean time, Hess should report the votes the Elliott candidates would have received if they hadn't been withdrawn, or at least what the withhold vote would have been by adding the totals from the Elliott proxy cards. To fail to do so not only disenfranchises every shareholder who returned an Elliott proxy card, but omits a fact necessary to make the voting results reported not misleading.

Stay tuned for more when the final results are filed.

Professorial Proxy Fight!

The heated proxy contest currenly under way at Hess Corp. has ignited a firestorm of professorial proxy fighting in the blogosphere. After an initial post by Usha Rodrigues, Stephen Bainbridge entered the fray and followed up with an additional post, in addition to blog volleys from John Coffee, Lawrence Cunningham, more from Lawrence Cunningham, and more from Usha Rodrigues, in addition to many others.These blog posts add to the voluminous comments of academics quoted in the proxy materials themselves. The swirling controversy is all summed up in a recent piece by Steven Davidoff'.

Why has this particular campaign stimulated so much professorial proxy pugilism? As background, Elliott Management launched a campaign to elect five directors to the Hess board. As part of the campaign, Elliott agreed to a plan (now abandoned) to compensate those director nominees based on the stock price appreciation of Hess. The plan would pay the new directors $30,000 for each 1% the Hess stock price outperformed a peer group portfolio over a three-year period. Hess took the position that this compensation agreement was designed to serve "short term goals" and would "misalign board interests."  Elliott, on the other hand argued that the bonuses were designed to provide incentives for good corporate performance. 

The reason the bonus arrangement was so controversial is that it tapped into one (or more) of the longest-simmering debates under the surface of corporate law. That debate is whether there is a such thing as "long-term" shareholder value that differs from "short-term" shareholder value. Hess and its allies argued that the bonus arrangements would give Elliott's nominees incentives to favor "short term" stock appreciation over "long term" value. The implicit assumption is that there is, in fact, such a thing as "long term value" that differs systematically (and predictably) from "short term" stock prices. A second assumption is that three years is "short term." Really, the fundamental question is whether incumbent managers' performance is more accurately priced by the managers themselves or by the market. 

The long-term/short-term debate is so controversial because of incumbent managers' extreme aversion to the idea of accountability to the financial markets. When markets do not reward managers' actions with increased stock price, managers retreat to the argument that there is special, "long-term" value that they are creating but that markets don't perceive because markets are focused on the short term. Whether this is a dishonest tactic or merely a honest response to the cognitive dissonance of a negative market reaction, managers have succeeded in averting attention from the market's assessment of their performance. 

The Elliott/Hess battle is shaping up as the opening skirmish in the coming war over the issue of "short-termism" in corporate governance. The Hess contest went nuclear because it has broken the academic truce that had reigned since end of the takeover battles of the 1980s. As part of the truce, commentators have largely played along with incumbent managers' arguments, accepting the fiction of what Kraakman and Black called "hidden value" to avoid confronting the role of market discipline in corporate governance. The increasing clout of institutional investors and other changes in the governance landscape, however, have reinvigorated the idea that long term/short term distinction is a subterfuge deployed by managers to further their own self interest and avoid accountability.

In many ways, the Hess battle merely reflects the cracks in the monolith of "hidden value" thinking that has dominated the Delaware courts for decades. In recent months, Lucian Bebchuk and Mark Roe have written important papers on the topic of short-term and long-term value. I myself am working on a draft that I hope will bring some modest contribution to this issue. The long-term/short-term value issue is in some ways the most important one in corporate governance today, and the increasing influence of institutional investors will mean that courts cannot hide from this issue forever.

I will not comment on the specific merits of the Hess nominees versus the Elliott nominees, in part because I fear the arbitrary application of Rule 14a-9 more than other commentators. But stay tuned for more after the results of the proxy contest on Thursday!