Corporate Governance

Access and a Desperate Response

By J Robert Brown Jr.

As we have noted on this blog, opposition to access has been absolute and shrill.  As a result, opponents of access have lost at every stage.  Rather than accept the ridiculously narrow access bylaw proposed under the Cox Commission (perhaps with a 5% threshold), oponents now confront direct access at much lower thresholds.

Rather than accept the SEC's more recent access proposal (but perhaps seeking significant ownership thresholds), opponents threatened to sue.  The result was language in Dodd-Frank that is so broad, the SEC can do whatever it wants in the access area, including relying on the existing thresholds in Rule 14a-8 (the lesser of 1% or $2000) or eliminating any requirement that shareholder nominees be a short slate. 

The next stage of virulent opposition seems to be coming from JW Verrett in posts on Truth on the Market.  He is proposing a series of "defenses" designed ostensibly to minimize the significance of access. His "suggestions" have earned a spirited retort from James McRitchie at CorpGov and support from Steve Bainbridge (who actually doesn't support Verrett's analysis, only his right to propose methods of circumventing the access requirement). 

As we will show, the approach used by Verrett is both bad law and bad policy but frankly an invaluable service to anyone arguing for further federal preemption of federal law.  He for example proposes the following:

• The Delaware General Corporation Law gives Boards a wide authority to delegate matters to subcommittees of the Board.  The full Board must approve changes to the charter or bylaws, but otherwise nearly all matters considered by the Board can be delegated to Committees.  If the SEC's last proposal on proxy access is approved pursuant to Dodd-Frank, including the rule that shareholders can nominate up to a quarter of the board, then Boards could simply create an Executive Committee of the Board consisting of the incumbent directors constituting the other 75% of the Board and delegate nearly every major decision to that Committee.  The insurgent directors could be barred from the Committee meeting.  They would be given the minutes of the meeting, prepared by the corporate secretary, and otherwise be excluded from the deliberations.

The proposal does not contradict or minimize access.  It is really a road map for boards seeking to minimize the influence of directors who in any way oppose management.  The same approach could be taken, for example, to eliminate from the board any director who demonstrates excessive amounts of independence or opposes the CEO in any significant manner.  In other words, its not about access but about eliminating dissent. 

The use of the executive committee in the manner suggested by Verrett is probably a violation of the board's fiduciary duties.  After all, it amounts to the full fledged exclusion of directors solely because the board does not like the way they were elected.  Moreover, the standard of review would likely not be the business judgment rule or even the duty of loyalty but the Blasius standard since this would effectively be an act of disenfranchisement.  As a result, the burden would be on the board to establish a compelling justification for the action, which it could not.

Moreover, the case is awfully close to Crown Emak Partners v. Kurz, 992 A.2d 377 (Del. 2010), where the Court invalidated a bylaw that reduced the size of the board, concluding that this was not an approved method of removing incumbent directors.  Verrett's proposal is tantamount to removal of the dissident directors by the board, something that Delaware law does not permit.  

And, while its true that the board can delegate to committees (see Brehm v. Eisner, 906 A.2d 27  (Del. 2005); 8 Del. C. § 141(c) (2010)), the Delaware Supreme Court struck down another circumvention of the board's authority in Quickturn.  Like in Quickturn, this provision would permanently divest the entire board of its authority. 

The legal uncertainty would also generate uncertainty over actions taken by the executive committee, probably damaging the company's business.  The legal uncertainty of the approach would likely cause third parties to avoid any transaction that otherwise required full board approval (signifcant contracts, the delegation of authority to officers, the sale of stock, significant loans, etc). 

Of course, any attempt to challenge the approach in Delaware would confront the pro-management approach of the courts.  As a result, its possible that the courts would find this approach legal. 

If so, it would be a windfall to shareholder groups.  The board's approach would likely generate support for a competing slate of directors in the next election cycle, resulting in displacement of the entire board.  It might generate an SEC response, such as allowing access for a majority of the board, at least where the incumbents effectively refuse to seat dissident directors. (This is, after all, something the SEC could do given the extraordinarily broad language of Dodd-Frank). 

Mostly, though, the approach is shortsighted, at least for anyone seeking to minimize additional preemption of Delaware law.  The obvious unfairness of the approach would be a red flag for Congress the next time talk of preemption surfaced.  Congress preempted Delaware in 2002 with SOX and again in Dodd-Frank.  Dodd-Frank in effect gave the SEC the authority to determine the definition of independent director, overturned Citigroup by forcing on the boards of financial institutions to take a role in the risk management process, and required independent compensation consultants, a step Delaware courts refused to take.

The pace of preemption is increasing.  Delaware has been reduced from the center of corporate governance to another interest group vying for a role in the governance process.  In those circumstances, congressional intervention is becoming easier and easier.  Upholding efforts by boards to eliminate dissident directors through broad delegation to the executive committee will merely hasten the next round of intervention.   

Full post as published by The Race to the Bottom on July 29, 2010 (boomark / email).