CLS Blue Sky Blog

Milbank Discusses Universal Proxy and “Horizontal” Conflicts

There is reason to believe the SEC’s new universal proxy Rule 14a-19 will result in more stockholder nominees being elected to the boards of public companies.

First, the rule allows voting stockholders to make their own ad hoc choice of nominees from the slates proposed by management, on one hand, and by the nominating stockholder, on the other. The ability to more easily “split the ticket” will no doubt appeal to proxy advisors and others eager to display Solomonic wisdom (and forgetting that Solomon did not really advocate splitting the baby).

Second, the new rule eliminates the need for activists to mail their own proxy card. This paves the way for a low-cost alternative to a traditional proxy fight. A low-cost alternative, if it materializes, may tempt smaller activists—perhaps including better-funded versions of the “issues” activists now plastering corporate boardrooms with various 14a-8 stockholder proposals—to nominate one or two directors to press their concerns in the boardroom.[1]

However, Rule 14a-19 does not address the longstanding question of just what information the nominating stockholder should disclose to voting stockholders. The current disclosure obligations set forth in the Schedule 14A form of proxy statement are designed almost exclusively to elicit disclosure from a nominating corporation, not a nominating stockholder.[2] These disclosure rules, even after Rule 14a-19’s adoption, fail to address the fundamental difference between a stockholder nominating a director to the board, and a corporation nominating a director to the board. As a result, the rules fail to elicit material information necessary for voting stockholders to make an informed decision on the election of stockholder nominees.

I. More Choice Requires More Information

When a corporation (really, the board of a corporation) nominates a director, it may do so to add expertise in a particular skills area, to include a new viewpoint on an old problem, to increase diversity, or simply to bring in some fresh blood—ideally with the goal of creating a balance of skills, temperaments and experience that will enhance the long-term management of the corporation. Even (or perhaps especially) when the board fails to adhere to this ideal, the board’s overall views and tendencies will have already been amply demonstrated by its track record in running the company, and stockholders, simply by understanding the nominee’s background and qualifications, can make an informed decision on the candidate.

When a stockholder nominates a director however, a host of questions arise that are qualitatively different. The answers will be material to stockholders asked to vote on the nominees.

The first questions involve the extent of the nominee’s independence from the nominating stockholder—will the nominee be free from influences exerted by the nominating stockholder? Or does the nominee intend to serve as a faithful representative of an activist stockholder or a special interest group (favoring, for example, immediate voluntary carbon reduction or the elimination of plastic packaging)? These questions have always deserved attention, but are taking on greater importance given the increased understanding of “horizontal” conflicts of interest that may arise “between activists (who tend to be short-term shareholders) and indexed institutional investors (who tend to be long-term investors and regard themselves as the company’s ‘permanent shareholders’).”[3] Delaware courts have recognized that these conflicting interests can result in stockholder nominees or activist appointees on boards becoming “dual fiduciaries” with split loyalties.[4] Disclosing the existence and extent of any such split loyalties will be critical to voting stockholders.

Even where it is clear that the nominee is completely independent from the nominating stockholder, the nominating stockholder presumably has a compelling reason for engaging in a proxy fight, so the voting stockholders will need answers to an additional level of questions to better understand the interests, agenda, plans and proposals of the nominating stockholder, and how the nominee is expected to further that agenda. Voting stockholders, in short, deserve to be told in a frank manner whether the nominees are expected to work as part of a balanced board, or are in fact being nominated to unbalance the board and push it hard in a particular direction.

Until the SEC addresses this disclosure gap, corporations have the opportunity, and indeed a positive duty, to require nominating stockholders to provide voting stockholders with the material disclosure needed to inform their vote. Directors as a matter of course should have robust information about the independence and aims of director nominees before recommending a vote for or against their candidacy.[5]  Once in possession of such information, directors “have a fiduciary duty to disclose to the shareholders the available material facts that would enable them to make an informed decision[.]”[6] Advance notice bylaws are the natural vehicle for ensuring that this disclosure is made. As the Delaware Chancery Court has noted, advance notice bylaws serve “an important disclosure function, allowing boards of directors to knowledgably make recommendations about nominees and ensuring that stockholders cast well-informed votes.”[7]

II. The Role of Advance Notice Bylaws

Advance notice bylaws typically fulfill the disclosure function by requiring stockholder nominees to provide detailed information in response to the bylaw itself and a lengthy director questionnaire. There is a wide diversity of practice as to exactly what information the stockholder nominees must disclose, with some bylaws and questionnaires broadly covering the nominee’s conflicts and the nominating stockholder’s alliances and interests, while others are more narrowly focused on information required for regulatory filings. As suggested below, the bylaws and questionnaires should seek to elicit specific and detailed information about the conflicts and allegiances of the nominating stockholder and the nominee, as well as of the plans, proposals and agenda of both. Until the board has obtained and understood this information, it cannot be said to have complied with its duty of care in endorsing or rejecting a proposed nominee or, in the case of a settlement, appointing a nominee to the board.

It would also seem prudent (though hopefully redundant) for the advance notice bylaw to require that any material information disclosed to the corporation pursuant to the bylaw or director questionnaires also be disclosed to stockholders promptly as part of the proxy statement or pursuant to Rule 14a-12 as a pre-filing solicitation.[8] It appears that nominating stockholders sometimes do not consider themselves bound by Rule 14a-12 until well after the date when notice of a nomination is given to the corporation. The bylaw should establish that, after the nomination notice to the corporation is given, communications by the nominating stockholder to other stockholders will be presumed to be “reasonably calculated to result in the procurement, withholding or revocation of a proxy.”[9] Once the nominating stockholder submits its notice, all stockholders would then have equal access on a timely basis to communications made by the nominating stockholder.

Corporations should also consider requiring disclosure of material presented to other stockholders prior to delivery of the stockholder’s nomination notice. If that material was used in contemplation of soliciting support for the stockholder’s nominees, disclosure would be wholly consistent with the requirements of Rule 14a-12. Even if the material was used more broadly to solicit support for the nominating stockholder’s agenda before the nomination was contemplated, such material and the identity of stockholders selected for early recruitment should be disclosed. There is no reason that stockholders contacted earlier in the process to build support should have more or different information than other voting stockholders. As discussed below, such disclosure would give voting stockholders a view into the consistency of messaging by the nominating stockholder and into the support network built by the nominating stockholder.

Note that, consistent with the general approach to advance notice bylaws, stockholder nominees typically may be disqualified by the board if the advance notice bylaws are not complied with. Accordingly, materially defective disclosure by the nominating stockholder could result in disqualification of its nominees.  Such a remedy would have to be exercised with care, but should in fact be exercised where there is a material breach of a “clear and unambiguous” bylaw.[10]  Directors have a duty to protect the stockholder franchise, and ensuring some measure of proper disclosure is a critical to that task.

The disclosure items that the bylaw and director questionnaires should cover are discussed further below.

III. Improving Disclosure

A. Independence

A threshold question for a voting stockholder is whether a stockholder nominee is working primarily for the nominating stockholder, or for all stockholders. If the nominee has conflicting loyalties, those should be laid out in detail for voting stockholders.

Questionnaires should require information on whether the nominee is an employee, officer, partner or co-investor of the nominating stockholder. The questionnaire should also solicit information about any “golden handcuff” arrangements, whereby the nominating stockholder or its affiliates will reward the nominee for achieving a particular result as a director (e.g., sale of the corporation, stock price increase, or implementation of a new ESG policy). As a measure of the nominee’s independence, the questionnaire should require disclosure as to whether the nominating stockholder or its affiliates has nominated the same nominee for other board seats, [11] has paid for the professional services of the nominee or has other financial or familial ties to the nominee.

Beyond understanding the financial, personal and professional independence of the nominee, the degree of substantive alignment between the nominating stockholder and the nominee will be important to voting stockholders. For example, a stockholder will wish to know whether, as part of the vetting process, the nominee and the nominating stockholder have had substantive conversations about their views on the quality of management or any particular initiatives that the nominee would support (from replacing certain management members to examining strategic alternatives to reducing investment in carbon producing activities).  The content of these alignment conversation will be as important to the voting stockholders as they were to the nominating stockholder, and disclosing this information will help voting stockholders judge whether the nominee was selected to implement a particular agenda or to function as a truly independent and open-minded director.

(Note that if a company chooses to require this alignment information from a nominating stockholder, it may also wish to disclose whether its own nominating committee has had similar alignment conversations with the company’s director candidates on topic such as, e.g., retention of the CEO. As noted above, the company’s positions, and that of its nominees, will likely not be much of a surprise to its more attentive stockholders, but stockholders will rightly be interested in whether alignment on specific topics of corporate policy was confirmed as part of the nominating committee’s process. While some commentators have insisted that equivalence of information solicited from stockholder nominees and from company nominees is required across the board as a matter of “fairness” to the nominating stockholder, the nominating stockholder and the company are in fundamentally different positions, so the goose/gander rule really does not apply—the test should be whether the required disclosure would reasonably be expected to be material to voting stockholders.)

One additional item of disclosure that is strongly indicative of the ties between the nominating stockholder and the nominee is whether the nominee will take advantage of a common law exception to board confidentiality policies. This exception allows the nominee, as a director, to discuss confidential information of the board with the nominating stockholder on an ongoing basis. It would certainly be material for the voting stockholders to know whether the nominee they are being asked to vote for will be in regular contact with the nominating stockholder about confidential board deliberations, and whether the nominating stockholder will continue to weigh in with the nominee outside of the board meetings advocating for its preferred positions on topics of importance to all stockholders. Voting stockholders will also want to know whether the nominee will be expected to present to the board analyses prepared by the nominating stockholder and/or its advisors.

This exception to board confidentiality policies is available only “when it is understood that the director acts as the stockholder’s representative[.]”[12] Accordingly, as a matter of Delaware law, it is incumbent  on any nominating stockholder planning to take advantage of this exception to very clearly disclose to voting stockholders that the nominee will be acting “as the [nominating] stockholder’s representative.”[13] Without such disclosure, there can be no “understanding” that a special relationship of communication, information sharing and consultation will exist, and any disclosure of confidential information by the nominee to the nominating stockholder may be viewed as a breach of the duty of loyalty.

(While the issue did not seem to have been directly raised in Kalisman, quoted above, it is an interesting question as to whether such an “understanding” can be created by the board of a public company without a vote of stockholders, as is the case when the board appoints an activist’s nominee to the board in settlement of a real or threatened proxy fight. The existence of the “understanding” excuses what may otherwise be a breach of the duty of loyalty by the nominee. With one exception, it is hard to think of another circumstance where the board can of its own volition excuse such a breach.[14] The question seems to come down to whether the “understanding” can be solely between the board and an activist, or whether it is the stockholders’ “understanding” that matters. One would think that it would require action by stockholders to waive a breach of fiduciary duties in a Delaware corporation, if in fact such duties can be waived.[15])

B. Interests, Intentions; Schedule 14A and Rule 13d

Schedule 14A, the SEC’s proxy statement form, requires disclosure of the nominating stockholder’s position in securities of the target company, its trading history and contracts, arrangements and understandings that the nominating stockholder has entered into with respect to the target’s securities.[16] While this disclosure is of course critically important to stockholders, it is also extremely limited and does not begin to elicit the full scope of information that will be material to a voting stockholder. To supplement the requirements of Schedule 14A, one can look to Rule 13d.

Rule 13d disclosure obligations were designed to give the market notice of important information about a stockholder’s interests and intentions when that stockholder is acting with the purpose of “changing or influencing control of the issuer.” [17] As such, the rule provides a good baseline of disclosure for stockholders seeking to place their candidates on boards.  While Rule 13d uses the accumulation of shares as the trigger for disclosure, the accumulation of shares is simply one objective signal that an attempt to influence or obtain control of the corporation may be underway. Seeking to nominate one or more directors to the board provides an unambiguous signal that such an attempt has begun.

Certain key aspects of Schedule 14A and Rule 13d disclosure—with suggested enhancements appropriate for informing voting stockholders of material facts in the context of a stockholder nomination—are discussed below.

  1. Shareholdings, Derivatives and Investment Horizons.

Rule 13d and Schedule 14A disclosure requirements regarding the nominating stockholder’s trading history and holdings of target securities and derivatives largely overlap,.[18] Both Schedule 14A and Rule 13d implicitly recognize that a voting stockholder will want to understand fully both the voting power that can be mustered by the nominating stockholder and its  economic motivations.[19] This information helps the voting stockholder judge its economic alignment with the nominating stockholder.

Further to this goal, corporations should consider requiring disclosure of the investment horizon of the nominating stockholder. This may be of significant interest to voting stockholders, particularly to index funds and other long-term investors that view themselves as near-permanent capital. If the typical investment horizon of the nominating stockholder is just a year or two, voting stockholders will want to be put on notice that the nominating stockholder will likely be seeking to maximize the return available to it in the near term. A nominating stockholder with a limited investment horizon may not be shy about cutting R&D expenses or long-term capital expenditures in favor of shorter-term payouts, or may be less adverse to incurring debt to finance a large dividend in the near term, even if financing costs will rise as a result.[20] A longer-term investor may well have different views on these matters, or on the premium achievable in a near-term sale.

Underlining the importance of disclosing the nominating stockholder’s investment horizon is the recent Chancery Court opinion in Goldstein v. Denner: “For similar reasons, particular types of investors may espouse short-term investment strategies and structure their affairs to benefit economically from those strategies, thereby creating a divergent interest in pursuing short-term performance at the expense of long-term wealth.”[21]  This may be a particular concern where the nominating stockholder is an activist hedge fund – “the archetypal short-term investor.”[22] Accordingly, ensuring that voting stockholders understand nominating stockholder’s investment horizon would seem to be an appropriate function of advance notice bylaws.

2. Arrangements, Understandings, Acting in Concert and Solicitations of Support

The identity of the persons who are putting forward and supporting a stockholder nominee is considered critical information for stockholders deciding how to cast their votes.[23] In determining the enforceability of an advance notice bylaw, the court in CytoDyn found that the identification of persons supporting the nomination “was vitally important information; the [b]oard was not nitpicking when it flagged the omission as material and ultimately disqualifying.”[24] The importance of identifying which stockholders are aligned with the nominating stockholder is also implicit in Schedule 14A, both in the requirement that each member of a “group” that includes the  nominating stockholder be deemed a “participant” in the solicitation, and in the requirement that any “contract, arrangement or understanding  with any person with respect to any securities of the registrant” be disclosed.[25] But determining exactly when a “group” has been formed or an “understanding” reached presents interpretation issues.[26]

Consider the following scenario: a nominating stockholder makes a private, substantive presentation on its investment thesis to a select group of stockholders. This presentation occurs prior to the time that a filing obligation arises under Rule 14a-12—either because the presentation is an “exempt solicitation” (e.g., it is being made to fewer than 10 current stockholders) or simply because it is such early days that the presentation is not made “under circumstances reasonably calculated to result in the procurement” of a proxy.[27] At the end of the presentation, a stockholder says to the nominating stockholder, “This is great, I fully agree with your thesis, intend to support you in achieving the aims you have outlined, will act in concert with you and will vote my shares with you if it comes to that.” The nominating stockholder replies, “Thank you—I’m glad we have an understanding.” This clearly creates a disclosable “understanding,” and may well create a “group” for purposes of Schedule 14A and Rule 13d (and, perhaps more consequentially, for purposes of the short swing profit rule of Section 16).

But is there an understanding if the stockholder says instead, “I am fully on board with your investment thesis,” and the nominating stockholder (though clearly intending to convince the investor of the thesis) does not reply? Was the presentation equivalent to an offer and the response of being “fully on board” an acceptance for purposes of creating an “understanding” disclosable under Schedule 14A? Or what if, after the meeting, the investor says nothing in particular but then buys up two percent of the issuer? Is that purchase an acceptance of a unilateral contract evidencing a mutual arrangement or understanding? The point is that there may be cases where it may not be simple, even for the nominating stockholder, to know whether a group has been formed or an understanding has been reached, or how complete or permanent such group or understanding between the parties may be.  It can be a tricky thing to have to disclose, particularly if the stockholders have internalized the immortal advice of Mr. Lomasney – “never write if you can speak, never speak if you can nod, never nod if you can wink”.

The complexity of defining just when an agreement or understanding has been reached in such circumstances seems to have resulted in some practitioners following a convenient, but wholly invented, bright-line rule—that unless both parties express a spoken or written agreement or understanding, there is none.[28]  Yet, given the clear intent of Schedule 14A to capture more than express agreements, the failure to expressly confirm an agreement or understanding with respect to the issuer’s securities should not be a complete shield to disclosing material contacts and relationships with other investors.

If the guiding principle of the advance notice bylaws is to elicit information material to voting stockholders, even where the nominating stockholder believes that its contacts with other stockholders have fallen short of forming a group (however defined in the future) or of creating an understanding or arrangement, these three questions may be appropriate:

  1. Did the nominating stockholder contact any other stockholders seeking support for its investment thesis beforepublicly announcing that it would seek to nominate directors to the board? If so, please identify those stockholders.
  2. Was any material information disclosed to such other stockholders that was not previously or simultaneously disclosed publicly pursuant to Rule 14a-12?
  3. Did any of such stockholders express support for the nominating stockholder’s investment thesis, even if that expression of support came short of creating a group, understanding or arrangement?

The answers to these questions will presumably be of interest to all stockholders wishing to understand how the nominating stockholder built its constituency. If there are objections that such a rule would impair communications among stockholders, those objections can be met by emphasizing that the content of the communications (which presumably should be in substance the same as what is disclosed to all stockholders) is the only messaging that needs to be disclosed. There need not be an obligation to disclose the statements of the attendees, other than those statements that evince support. Since all stockholders should eventually receive the information disclosed in the presentation, it would not seem prejudicial to simply note which stockholders were chosen to receive that information early.

Requiring disclosure of those stockholders selected for early recruitment to the nominating stockholder’s point of view might take some of the pressure off the determination of whether those attendees have come to an understanding with the nominating stockholder or are part of a “group” for purposes of Rule 13d, Section 16 and Schedule 14A. More importantly, this type of disclosure would give voting stockholders critical information about whom the activist chose to approach in building its initial support network, whether explicit or implicit promises have been made to, or expectations set for, that support network and the consistency (or lack thereof) between the nominating stockholder’s private and public messaging. Disclosing which stockholders were initially recruited, the timing of those early meetings and the messages delivered in the private context will help ensure “that stockholders cast well-informed votes”—and is material regardless of whether Schedule 14A would otherwise mandate its disclosure.[29]

3. Plans and Proposals

Perhaps most significantly, meaningful disclosure to voting stockholders must include disclosure of the plans and proposals of the nominating stockholder with respect to its investment. As noted above, the existing proxy disclosure rules—which seem in large part to assume all director nominations will be made by the board or that all shareholders have identical interests—do not require the nominating stockholder to make any disclosure whatsoever of its “plans and proposals.” This is a bit weird, because there are no doubt reasons why the nominating stockholder is nominating one or more directors – goals it wishes to achieve, or changes it wants the company to implement. And the nominating stockholder will presumably wish to disclose those goals in order to convince stockholders to vote in favor of its nominee. But to leave the contents of such disclosure (and even the choice as to whether to make any such disclosure) to the unfettered discretion of the nominating stockholder would be the same as, for example, allowing management unfettered discretion as to the contents of the “Management Discussion and Analysis” section of the company’s 10-K. Such a regime is an open invitation to tailor a message that is consistent only with the self-interest of the disclosing party.[30] Even if the SEC has not seen the need to fill in this very large gap in its proxy disclosure regime, as a matter of Delaware law, it is incumbent on the board to take prudent steps to ensure that proper and complete disclosure of the nominating stockholder’s “plans and proposals” be presented to stockholders before the vote is held.

While Schedule 14A fails to provide adequate guidance on “plans and proposals”, corporations can look to Rule 13d as a baseline for disclosure requirements applicable to a nominating stockholder’s intentions. Specifically, Item 4 of Schedule 13D requires disclosure, among other things, of “any plans or proposals . . . which relate to or would result in” acquisitions or dispositions of the issuer’s securities, mergers, reorganizations, material asset sales, changes in the board or management, changes in dividend policy and any other material change to the issuer’s business or corporate structure, including spin-offs.[31]

It should be noted however, that while the text of Item 4 provides a practical outline of the type of information that would be useful to stockholders, Item 4 disclosure in practice has become nothing more than the recitation of a generic litany of every corporate action possible—as broad as it is meaningless.[32] The filing person will disclose that it may consider any plan or proposal under the sun, without giving any indication as to whether any such plans or proposals have actually been considered, formulated, approved internally, shared with other investors, or even shared with the company.

One could argue (maybe with a straight face) that this sort of disclosure is appropriate in a Rule 13d context. The Rule 13d disclosure requirements are essentially an early warning system, alerting stockholders that a change of control transaction, or board election, may happen. At the time of a typical Rule 13d filing, there is no decision to be made by the stockholders beyond deciding to hold or sell their shares—any tender offer or board nomination comes later and provides stockholders an opportunity to vote their concerns. But information about the nominating stockholder’s plans and proposals is much more critical in the context of board nomination.  In the context of a board nomination, the stockholders are being asked to exercise their franchise and should have all information pertinent to their decision at that point—not six months after they have elected the stockholder nominee.

A more cynical view of why this sort of useless disclosure has become common is that there is very little consequence to bad disclosure under Rule 13d.  Although the corporation has a private right of action with respect to disclosure violations under Rule 13d, other than ordering proper (though belated) disclosure, there is no remedy associated with bad disclosure under Rule 13d.[33]  This is another reason why it is critical that advance notice bylaws require prompt disclosure under Rule 14a-12 or in the proxy statement—Rule 14a-9 provides a remedy for bad disclosure in a proxy contest. Disclosure of “plans and proposals” will be consequential to the voting stockholders, and inaccurate disclosure should hold consequences for the nominating stockholder.

Beyond creating remedies under the securities laws, if advance notice bylaws require the disclosure of the nominating stockholder’s “plans and proposals”, one could imagine a Delaware court upholding the disqualification of a stockholder nominee for materially deficient disclosure—such as the case where the sum and substance of the disclosure made is an unlimited list of possibilities.[34]  A Delaware court may also be interested in a more typical disclosure discrepancy in proxy fights, where the background section of the company’s proxy statement recites repeated explicit demands by an activist, which demands are not fully reflected in the activist’s proxy statement. This proxy statement disclosure will come after the nominating stockholder has invested a large amount of money in the company’s stock, undertaken various financial and operational analyses of the business, initiated the process of nominating a director candidate and spent additional money to recruit other stockholders to its vision.  That vision needs to be made clear and should be consistent with, or at least reconciled to, prior messaging to the company. Given how critical this information is to the exercise of the stockholder franchise, and the lack of any mandated disclosure by the SEC, it is incumbent on corporations to ensure that any disclosure of a nominating stockholder’s “plans and proposals” be more thorough, accurate and informative than the typical Rule 13d disclosure on the topic.

4. Material Analyses

In addition to the problem of generic and overbroad disclosure of “plans and proposals,” Rule 13d disclosure practice runs into another problem—defining the exact moment when an idea becomes a “plan or proposal.” Consider the case where the nominating stockholder is advocating for an examination of strategic alternatives, a fairly typical platform. Assume that the nominating stockholder has already performed an extensive analysis of its investment returns over selected timeframes under a variety of different liquidity alternatives, from a buyback funded by cash saved by a reduction of operating expenses, to a leveraged recap, to a PIPE investment, to a sale of the company.  It is clear from the analysis that the nominating stockholder’s returns will be maximized if the nominating stockholder funds a PIPE investment. Shouldn’t voting stockholders be told that a conflict transaction is in the nominating stockholder’s best interest, and preferably before voting? Or is it critical that the PIPE investment first be defined as an actual “plan or proposal” (an oft-disputed term in Rule 13d practice)?[35] One suspects most voting stockholders would find the analysis of the PIPE to be material, regardless of how the nominating stockholder chooses to characterize its intentions arising from that analysis.[36]

Or, even absent conflict transactions, consider the case where a quick sale of the company to a third party will maximize the nominating stockholder’s return. Shouldn’t voting stockholders be told that a quick sale of the company will maximize the nominating stockholder’s return? The court in CytoDyn certainly thought so, stating “as a factfinder, I do have a view of whether information relating to the possibility of a future transaction would be material to stockholders. It would be.”[37] Voting stockholders may have any number of reasons for holding disparate views on a proposed transaction, from having a higher basis in the company’s stock to having an investment horizon that is longer than that of the nominating stockholder. And if the nominating stockholder already has a point of view on the best outcome of a strategic alternatives review, and economic reasons to press for that outcome over others, voting stockholders should know that, and should be given the information needed to judge whether they are sufficiently aligned with the nominating stockholder’s economic interests to vote for the nominating stockholder’s candidate.

It is an ultimately unrewarding disclosure puzzle to try to figure out whether a particular corporate strategy evaluated by the nominating stockholder constitutes an actual “plan or proposal”—it is neither necessary nor particularly helpful. If the nominating stockholder has completed analyses demonstrating that economic factors strongly bend its plans and proposals for the company in a certain direction, those analyses and economic factors should be fully disclosed to the voting stockholders—even if not yet formalized by the nominating stockholder into a “plan or proposal.” Stockholders will be rightly interested in factors that significantly influence the investment strategy of the nominating stockholder and its nominee. This is particularly true if the nominee may be considered the nominating stockholder’s “representative” or the interests of the nominee and the nominating stockholder have otherwise converged. Withholding disclosure on the grounds that nothing has coalesced in the mind of the nominating stockholder into a “plan or proposal” —a typical position in Rule 13d practice—is to have disclosure turn on definitional game playing, rather than a clear-headed analysis of whether “there is a substantial likelihood that a reasonable shareholder would consider [the information] important in deciding how to vote[.]”[38]

IV. Settlements

It is important to underline that all the information the board should have in the context of a stockholder nomination should also be sought by the board in the context of activist settlements. The vast majority of board seats won by activists are won by settlement,[39] and it is likely that a large number of those settlements happen well before notice is given under advance notice bylaws;[40] accordingly, a number of these settlements may be reached before the board has received full information about the appointed directors’ independence or alignment with the activist, or about the activist’s interests and aims. In cases where the settlement entitles the activist to subsequently exercise its full discretion in choosing a nominee, it is startlingly clear that the board has not done proper diligence on the question of whether the nominee will be a fiduciary of the nominating stockholder.

The prevalence of board seats won by settlement has been a source of understandable frustration to institutional investors for some time now. In 2016 State Street published a letter setting forth a detailed analysis on how activist settlements have resulted in its effective disenfranchisement.[41] The former head of Blackrock’s America’s Corporate Governance team, Zach Oleksiuk, put the problem rather succinctly: “We remain skeptical of directors that are overly focused on a single issue or represent a subset of shareholders.”[42] And Blackrock, State Street and Vanguard in their complaints regarding activist settlements have all implicitly or explicitly acknowledged  ‘“horizontal’ conflict[s] between interests of the activist and the other shareholders [regarding] the choice and agenda of the new directors.”[43]

It does not help that the settlement process occurs quickly, without much explanation or justification to shareholders, and with little or no disclosure of any information regarding the appointed directors’ independence from the activist stockholder, or the interests and aims of that stockholder. In announcing settlement agreements, companies tend to disclose nothing more than a paragraph on the appointees’ professional experience and perhaps a statement as to whether the appointees are employees of the nominating stockholder. The process that led to the appointments, and the factors considered in approving the appointments, exist largely in a black box for stockholders. These stockholders will be asked to vote for re-election of the activist’s nominees at the next stockholder’s meeting and may quickly be asked to vote on an important corporate transaction favored by the activist – in each case largely or completely without  disclosure regarding potential conflicts of the appointees, or the interests of the activist that selected them. More immediately, failure to make this disclosure at the time of settlement leaves stockholders guessing at exactly what the shift in board composition means for the future of the company. There is much room for improvement in announcing activist settlements.

Additionally, it is increasingly important for boards to consider duty of loyalty issues when giving away board seats in settlements.

In their article Activist Directors and Agency Costs: What Happens When an Activist Director Goes on the Board, Professor Coffee and his co-authors examine the “horizontal” agency costs that arise from activist engagements. The article makes a very strong case that activists, promoted by some as a dynamic agent acting (free of charge) to reduce the “vertical” agency costs of entrenched management, are in fact, like any agent, prone to extracting value for themselves.[44] And when one agent (the activist) negotiates with another agent (management), neither is offering to pick up the check.  Or, as Professor Coffee puts it, it is a “realistic assumption” that “once an activist appears and ‘engages’ a target company, that company’s management cannot be trusted to side with the majority of the shareholders.”[45] This assumption seems to be driven at least in part by the fact that Professor Coffee finds it difficult to identify material benefits arising from settlement to the corporation, other than “peace in our time” for management.[46] That benefit does not seem sufficient consideration to support awarding to the activist influence over  control of the company, particularly if the activist’s appointee will hold dual fiduciary roles. Questions about whether the company has benefited from the settlement agreement or whether only management has benefited by achieving a short-lived peace, lead directly to the duty of loyalty question: is there is sufficient evidence of self-interested behavior by directors in entering into a settlement agreement such that the decision to enter into the agreement will be subject to enhanced scrutiny?

Beyond academia, recent cases have taken up the logic of “horizonal conflicts” and resultant dual loyalties. In In re PLX Tech. Inc., the court noted that activist investors that “espouse short-term investment strategies and structure their affairs to benefit economically from those strategies . . .  [may create] a divergent interest in pursuing short-term performance at the expense of long-term wealth.”[47] While it is entirely possible that long-term and short-term investors interests align perfectly, “[i]f the interests of the beneficiaries to whom the dual fiduciary owes duties diverge, the fiduciary faces an inherent conflict of interest.”[48]

In In re PLX Tech. Inc., an activist succeeded in electing three directors (of a board of eight) through a proxy fight. The activist had been advocating in favor of a sale proposal, which the legacy board strongly opposed. Once seated, however, the board completely reversed course, forming a special committee and appointing a representative of the activist to head that committee. Agreeing to explore a sale process, and effectively turning over the sale process to an activist with divergent interests (along with a host of bad facts showing just how remarkably divergent the interests of long-term and short-term holders were in this circumstance) was enough to support a reasonable inference that “activist pressure” caused sitting directors to breach their fiduciary duties in the sale of the company. Quoting Chancellor McCormick’s formulation, the court found that the case involved “a conflicted fiduciary . . . insufficiently checked by the board . . . who tilt[ed] the sale process toward his own personal interests in ways inconsistent with maximizing stockholder value.”[49]

The facts in PLX, which involved a sale of the company, are readily distinguishable from a case where the board hands over seats to an activist in a settlement. Yet there is a question as to whether a board, like that in PLX, which “insufficiently checks” a conflicted fiduciary elected by stockholders is less culpable in some sense than a board that appoints one or more conflicted fiduciaries to the board in the first place—effectively creating the conflict without stockholder consent. Of course, in simply appointing dual fiduciaries to a minority of board seats, the existing board lives to fight another day, but the board should be well-prepared to carry on defense of the issues raised in the avoided proxy fight and should not allow the appointment to become just the first step in a reluctant acquiescence to the activist’s aims. Certainly, appointing dual fiduciaries to a special committee exploring a sale that the incumbent board fought against could be read, as in PLX, as the board insufficiently checking a conflicted fiduciary pursuing plans that may benefit one fiduciary over another. In some sense, the appointment of directors pursuant to a settlement would seem to counsel a rigidity of the position of the board, as changing course after the settlement will not have the blessing of stockholders that would be implied if the stockholders themselves had introduced the dual fiduciary into the boardroom pursuant to a proxy fight after full disclosure.

Protecting the stockholder franchise is a core duty of Delaware directors. Unless the board informs itself of all available material facts regarding a stockholder nomination, neither it nor the voting stockholders will have an adequate basis for making critical decisions regarding nominees. Gathering that information is the first step. Particularly in the absence of SEC disclosure requirements, directors have a duty to use advance notice bylaws and questionnaires to elicit all material information from the nominating stockholder and its nominees, and, once elicited, to ensure that information is further disclosed to voting stockholders.

Adding disclosure requirements designed to properly inform voting stockholders of material information only protects and strengthens the stockholder franchise, and should be viewed in a different light from, e.g., layering in burdensome technical requirements that may be of proscribed utility in helping to run a well-ordered shareholder meeting. Even if adding disclosure requirements to the advance notice bylaws were viewed as a potential defensive device subject to some form of enhanced scrutiny, it should be very clear that a badly informed vote interferes with the stockholder franchise much more than requiring disclosure of material information—even if the disclosure involves some inconvenience for the nominating stockholder or exposes conflicts or  strategies, plans and analyses that the nominating stockholder would prefer to keep to itself until after the election.


[1] While there is a deserved skepticism around the current ability of “gadflies” to fund and run a nomination campaign, that skepticism should be tempered by the strength of conviction held by many long-term investors on various ESG issues.  These smaller activists may not yet have in place the infrastructure and funding necessary to win a nomination campaign, but several are actively working on it.

[2] See 17 C.F.R. § 240.14a-101 (2023). Nominating stockholders do need to disclose their positions and trading history in the target’s securities, and any contract, arrangement or understanding with respect to the target’s securities, but on the question of nominee independence, aside from the possible disclosure of “golden handcuff” arrangements under Regulation S-K 401(a), independence and conflict disclosure requirements refer only to independence from and conflicts with the registrant (not with the nominating stockholder). See id. As argued below, the question of independence of a nominee from a particular stockholder in the case of stockholder nominations presents a more pressing concern for stockholders than independence of a nominee from the corporation the director is meant to serve. See John C. Coffee et al., Activist Directors and Agency Costs: What Happens When an Activist Director Goes on the Board, 104 Cornell L. Rev. 381, 393 (2019) (detailing the agency costs arising from “the ‘horizontal’ conflict between activists (who tend to be short-term shareholders) and indexed institutional investors (who tend to be long-term investors and regard themselves as the company’s ‘permanent shareholders’”)).  Moreover, there are no substantive disclosure requirements around the proposed agenda of the nominating stockholder or its nominee. See generally § 240.14a.

[3] See Coffee et al., supra note 2, at 393. “Horizontal” conflicts between groups of stockholders give rise to “horizontal” agency costs where one group of stockholders can “act opportunistically with respect to others.”  Such costs are contrasted with the “vertical” agency costs associated with holding management accountable.

[4] See Goldstein v. Denner, C.A. No. 2020-1061-JTL, 74 (Del Ch. May 26, 2022); In re PLX Tech. Inc. S’holders Litig., No. CV 9880-VCL, 2018 WL 5018535, at *104 (Del. Ch. Oct. 16, 2018), aff’d, 211 A.3d 137 (Del. 2019).

[5] See Aronson v. Lewis, 473 A.2d 805, 812 (Del. 1984) (Directors have a duty to inform themselves, prior to making a business decision, of all material information reasonably available to them).

[6] Turner v. Bernstein, 1999 WL 66532, at *5 (Del. Ch. Feb. 9, 1999) (citing Sealy Mattress Co. of New Jersey v. Sealy, Inc., 532 A.2d 1324, 1337 (Del. Ch. 1987). See also Wacht v. Continental Hosts. Ltd., Del. Ch., C.A. No. 7954, Berger, V.C. (April 11, 1986)).

[7] Strategic Investment Opportunities LLC v. Lee Enterprises, Inc., 2022 WL 453607, at *23 (Del. Ch. Feb. 14, 2022)(citing Del. Code Ann. tit. 8, § 109(b)) (emphasis added).

[8] This requirement should not create any additional burden on the nominating stockholder, as it will already have an obligation under Rule 14a-9 to avoid false or misleading statements and omissions. Rule 14a-9 provides stockholders with a direct remedy for material omissions or false or misleading statements by the nominating stockholder, providing real incentive for the nominating stockholder to update its soliciting material promptly. See J.I. Case Co. v. Borak, 377 U.S. 426, 433 (1964).

[9] 17 C.F.R § 240.14a-1(l) (defining “Solicitation”).

[10] See Strategic Investment Opportunities LLC, 2022 WL 453607, at *9 (quoting BlackRock Credit Allocation Income Tr. v. Saba Cap. Master Fund, Ltd., 224 A.3d 964, 980 (Del. 2020) (noting Delaware courts generally enforce clear and unambiguous advance notice bylaws to avoid “uncertainty in the electoral setting”)).

[11] See Goldstein, C.A. No. 2020-1061-JTL at 108 (the practice by activists of making repeat appointments to boards of target companies needs to be considered in judging the independence of a director from the activist that appointed the director).

[12] Kalisman et al. v. Friedman, et al., 2013 WL 1668205, at *6 (Del. Ch. Apr. 17, 2013). There is some tension in the phrasing of this test.  As Vice Chancellor Laster (the author of this test) has acknowledged, “Delaware law has consistently rejected the concept of so-called ‘constituency directors.’” J. Travis Laster & John Mark Zeberkiewicz, The Rights and Duties of Blockholder Directors, 70 Bus. Law. 33, 48 (2015). In short, while there may be an understanding that the nominee is acting “as the [nominating] stockholder’s representative,” the nominee is bound by its duty of loyalty to act on behalf of all stockholders. Kalisman, 2013 WL 1668205, at *6. Absent an understanding that a special relationship of communication, information sharing and consultation will exist, such a relationship cannot be consistent with the duty of loyalty owed to all stockholders.

[13] Kalisman, 2013 WL 1668205, at *6.

[14] The exception is in Section 122(17) of the Delaware General Corporation Law (“DGCL”), permitting a waiver of corporate opportunities. See Del. Code Ann. tit. 8, § 122(17) (2023). This seems to be the only provision of the DGCL expressly permitting a waiver of the duty of loyalty.

[15] See Manti Holdings, LLC v. The Carlyle Group Inc., C.A. No. 2020-0657-SG (Del. Ch. February 14, 2022) (noting that any such waiver would need to be plain and unambiguous, and questioning whether such a waiver of the duty of loyalty would be “unenforceable for reasons of public policy”).

[16] See 17 C.F.R § 240.14a-101, Item 5(b)(1)(viii).

[17] § 240.13d-1(b)(1). The impetus for the Williams Act may have been an increase in tender offer activity leading to change of control transactions, but Section 13d (and Rule 13d) both impose disclosure obligations without regard to the means by which control of a corporation may be obtained.

[18] See § 240.13d-101, Item 3 (requiring disclosure of source and amount of funds or other consideration) and Item 5 (requiring disclosure of interests in securities of the issuer).

[19] Note that Schedule 14A requires disclosure of “any contract, arrangements or understandings with respect to any securities of the registrant, including but not limited to . . . puts or calls, guarantees against loss or guarantees of profit, division of losses or profits . . .” § 240.14a-101, Item 5(b)(1)(viii). One would think this would be broad enough to elicit disclosure of, e.g., cash-settled total return swaps, but to avoid debate, advance notice bylaws can be written in a more explicit manner.

[20] John C. Coffee, Jr. & Darius Palia, The Wolf at the Door: The Impact of Hedge Fund Activism on Corporate Governance, 41 J. Corp. Law 545, 572, 573 (2016) (citing Brian Bushee, The Influence of Institutional Investors on Myopic R&D Investment Behavior, 73 Acc. Rev. 305, 330 (1998)).

[21] Goldstein, C.A. No. 2020-1061-JTL at 72 (quoting In re PLX Tech. Inc. S’holders Litig., 2018 WL 5018535, at *41 (Del. Ch. Oct. 16, 2018), aff’d, 211 A.3d 137 (Del. 2019)).

[22] Id. (quoting Marcel Kahan & Edward B. Rock, Hedge Funds in Corporate Governance and Corporate Control, 155 U. Pa. L. Rev. 1021, 1083 (2007)).

[23] See Rosenbaum v. CytoDyn Inc., 2021 WL 4775140, at *19 (Del. Ch. Oct. 13, 2021) (noting that “advance notice provisions are commonplace, and provisions asking stockholders to disclose supporters are equally ubiquitous”).

[24] See Rosenbaum, 2021 WL 4775140, at *49.

[25] § 240.14a-101, Item 4, Instruction 3(a) (iii), and Item 5(b)(1)(viii). Rule 13d is in accord, with a requirement that “contracts, arrangements, understandings and relationships (legal or otherwise)” with respect to securities be disclosed. § 240.13d-101, Item 6.

[26] Note that the SEC’s proposed deletion of the words “agree to” in Rule 13d-5(b)(1) will make interpretation of the word “group” even more difficult, and demonstrates the direction in which it believes future disclosure should be heading. See United States Securities and Exchange Commission, Release Nos. 33-11030, 34-94211; File No. S7-06-22, Comments On Modernization of Beneficial Ownership Reporting, 2022 WL 1608322, at *7 (2022).

[27] § 240.14a-1(l) (defining “Solicitation”).

[28] This bright-line rule seems to have developed in part from a confusion between the Rule 13d-5 definition of “group” which (to date) requires an actual agreement, § 240.13d-5(b), and Rule 13d-3 which simply requires a sharing of voting or investment power through “any contract, arrangement, understanding, relationship, or otherwise[,]” § 240.13d-3(a). In any event, it seems clear that the bright-line rule requiring an express agreement should not apply to Schedule 14A’s requirement that any “contract, arrangement, or understanding” with respect to the registrant’s securities be disclosed. § 240.14a-101, Item 5(b)(1)(viii).

[29] In the recent Politan case, there was much discussion around the request that a hedge fund disclose investors in its fund. See Politan Capital Management LP v. Joe E. Kiani et al., C.A. No. 2022-0948-NAC (Del. Ch. filed October 21, 2022). While one could understand the sensitivity about disclosing investors in the main hedge fund itself (which presumably holds multiple investments), disclosing the identity of investors who choose to invest in a special purpose vehicle of the hedge fund, which special purpose fund is organized for the purpose of investing in the target company, would seem to fall squarely into typical Schedule 14A and Schedule13D disclosure, and would surely be viewed as material information in the proxy statement context; for voting stockholders, it doesn’t get more basic than disclosing the makeup of the nominating group. See §§ 240.14a-101, Instruction 3(a)(iii); 240.13d-5 (“When 2 or more persons agree to act together for the purpose of acquiring . . . equity securities of an issuer, the group formed thereby shall be deemed to have acquired beneficial ownership . . . of all equity securities of that issuer beneficially owned by any such persons.”). See also § 240.13d-101, Item 6 (requiring disclosure of “any contracts, arrangements, understandings or relationships . . . among the [filing persons] and between any such persons and any person with respect to any securities of the issuer, including but not limited to . . . division of profits or loss . . . naming the persons with whom such contracts, arrangements, understandings or relationships have been entered into”).

[30] For example, a nominating stockholder advocating for a stock buyback could focus its disclosure exclusively on an anticipated stock price increase, without providing any analysis of potential increases in financing costs for the company going forward, or the opportunity costs of foregone investment. While the company can provide information about the costs of the stock buyback program to the stockholders, is there really an objection to requiring the nominating stockholder to evaluate and disclose the longer term consequences of the proposals it is selling to stockholders?

[31] § 240.13d-101, Item 4.

[32] An actual example: “The Reporting Person may consider, explore and/or develop plans and/or make proposals (whether preliminary or firm) with respect to, or with respect to potential changes in, the operations, management, the certificate of incorporation and bylaws, Board composition, ownership, capital or corporate structure, dividend policy, strategy and plans of the Issuer, potential strategic review or sale process involving the Issuer or certain of the Issuer’s businesses or assets, including transactions in which the Reporting Persons may seek to participate and potentially engage in.”

[33] See CSX Corp. v. Children’s Investment Fund Management (UK) LLP, 562 F. Supp. 2d 511, 570-572 (S.D.N.Y. 2008).

[34] See, e.g., Strategic Investment Opportunities LLC v. Lee Enterprises, Inc., 2022 WL 453607, 22-23 (Del. Ch. Feb. 14, 2022) (upholding exclusion of dissident slate as a result of nominating stockholder’s failure to timely present evidence of record ownership); Rosenbaum v. CytoDyn Inc., 2021 WL 4775140 (Del. Ch. Oct. 13, 2021) (upholding exclusion of a dissident slate based on failure to disclose interest in acquisition proposal and failure to disclose who was supporting proxy contest); Blackrock Credit Allocation Income Trust v. Saba Capital Master Fund, Ltd., No. 297, 2019 (Del. Ch. Jan. 13, 2020) (allowing certain BlackRock funds to exclude dissident slate as a result of nominating equityholder’s failure to timely submit director questionnaires).

[35] United States Securities and Exchange Commission, Exchange Act Sections 13(d) and 13(g) and Regulation 13D-G Beneficial Ownership Reporting, Question 110.06 (October 7, 2022), (noting that a plan or proposal “is not deemed to exist only upon execution of a formal agreement or commencement of a tender offer, solicitation or similar transaction”, but rather “when the security holder has formulated a specific intention with respect to a disclosable matter”).

[36] Disclosing analyses prepared in respect of a potential conflict transaction would be consistent with the requirements of Rule 13e-3. Rule 13e-3 of course requires such disclosure only when an insider is on the buy side of a take-private, but one could argue that the same principles apply when stockholders are asked to vote on the election of dual fiduciary directors who have determined that a particular transaction will favor the nominating stockholder to whom they own duties. Given the theory of horizontal conflicts, a full sale of the company could be viewed in this context as a conflict transaction if the benefits of a sale to the nominating stockholder are likely to exceed those available to other stockholders.

[37] Rosenbaum, 2021 WL 4775140, at *54.

[38] TSC Indus. Inv. v. Northway, Inc., 426 U.S. 438, 445 (1976).

[39] 92% of board seats won by activists in 2021 were secured through settlements with the target company. See Mary Ann Deignan et al., Lazard, 2021 Review of Activism 14 (2022).

[40] In 2021, all activist settlements awarding board seats appear to have been reached within 6 months of the initiation of the activist’s campaign, with 74% being reached within 3 months. See Sullivan & Cromwell, 2022 US Shareholder Activism and Activist Settlement Agreements, 14 (2022), Accordingly, it is unclear how often activists were even required to go to the effort of sending in their nomination notices and filling out director questionnaires.

[41] See Protecting Long-Term Shareholder Interests in Activist Engagements, State Street Global Advisors (October 10, 2016),

[42] Michael Flaherty, Big Funds Push Back against Activist Investor Settlements, Reuters (July 18, 2016),

[43] Coffee et al., supra note 2, at 400.

[44] Id. at 385 (“Unless the interests of the agent and the agent’s principal are perfectly aligned, this new agent will find ways to exercise its discretion opportunistically and in its own interests.”).

[45] Id. at 442.

[46] Id.

[47] In re PLX Tech. Inc. S’holders Litig., 2018 WL 5018535, at *41 (Del. Ch. Oct. 16, 2018), aff’d, 211 A.3d 137 (Del. 2019) (citing Glob. GT LP v. Golden Telecom, Inc., 993 A.2d 497, 508-09 (Del. Ch. 2010)); see also Goldstein v. Denner, C.A. No. 2020-1061-JTL, 102 (Del. Ch. May 26, 2022) (finding that investors with a short-term investment strategy involving an immediate sale of the company have a divergent interest from other stockholders who would gain if the company remained independent).

[48] Chen v. Howard-Anderson, 87 A.3d. 648, 670 (Del. Ch. 2014).

[49] Goldstein, C.A. No. 2020-1061-JTL, at 67.

This post comes to us from Milbank LLP. It is based on the firm’s memorandum, “MORE CHOICE REQUIRES MORE INFORMATION,” available here. 

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