Chapter 14: Shareholder Voting
Additional reading

When Facebook acquired WhatsApp for $19 billion in February, 2014, many outsiders
suggested that the purchase price was exorbitant. So who was responsible for this
decision? Facebook is a uniquely structured corporation, with Mark Zuckerberg—the
founder—retaining 57% of the voting rights of the company. Although Zuckerberg owns
far less than a majority of the outstanding shares, he previously purchased the voting
proxy from other investors to give him majority control. As a result, he has a decisive say
in the future of Facebook.
Chapter 15: Shareholder Information Rights
Scavenger hunt To give you a sense for how voting works in a public corporation, I’ve chosen the 2014 annual
shareholders meeting of GE. Please look through the questions in the attached “scavenger hunt”
to get a sense for the “proxy materials” used by GE for the meeting.


Here are the documents you’ll be looking through:
o Proxy statement (for 2014 annual meeting) [pdf]
o Proxy card (for 2014 annual meeting) [pdf]
o Annual report (FY 2013) [pdf]
In addition, you’ll find in interesting to browse the information available on the GE
"investor relations" website (typical of public corporations) and the voting results of the
2014 GE shareholders’ meeting:
o Investor Relations - Financial Reporting
o Voting results (4-23-14 annual meeing) / SEC Form 8-K (4-28-14)
Happy scavenging!
Overview
This chapter introduces you to -


how shareholders obtain corporate information under state law – namely, state inspection
statutes -- to facilitate their voting and to exercise their other shareholder rights
disclosure by the corporation to voting shareholders as required under both state law and
the federal proxy regime
the elements of proxy fraud actions:
o the implied federal proxy fraud action (including the elements of materiality,
culpability, reliance/causation, damages)
o the state-based duty of disclosure and how it compares to the federal duty
Summary
The main points of the chapter are --






Inspection rights cover the mundane (names of directors and officers), somewhat
interesting (shareholder lists) and really useful (books and records about corporate
business/affairs)
Stockholders (record or beneficial) can seek to inspect books and records upon meeting
certain procedural requirements
o must make written request under oath
o with proper purpose (DGCL 220)
o often subject to confidentiality stipulation
o must be "long" (not necessarily "net long")
Proper purpose must relate to a shareholder's financial interest in corporation
o must articulate some vote, voice, sue, sell - agenda to advance SWM
o other purposes can exist (according to Delaware courts)
o non-SWM purpose of antiwar activist is not valid (Pillsbury v. Honeywell case)
Shareholder ownership / record list
o in public corporations, stock held by intermediary DTC (CEDE)
o clients of brokerage firms must not object to being revealed to management
o inspecting shareholder receives list of ownership only if management already has
them
Federal law, specifically SEC rules, requires that any solicitation of shareholders in a
public company must include a disclosure document called a “proxy statement”
o A “public company,” under SEC rules, is a company that has a class of securities
listed on a stock exchange, or has a class of equity securities owned by 500 or
more holders of record and assets of at least $10 million.
Public companies are prohibited under SEC Rule § 14a-9 from making “false or
misleading statements” in a proxy statement
o Federal courts have fashioned an implied private right of action under Rule §
14a-9, on the theory that the SEC cannot review every proxy statement to ensure
its accuracy. [see Virginia Bankshares, Inc. v. Sandberg]
Statutes
These statutes are relevant:




DGCL § 220
Securities Exchange Act of 1934 §14(a)
Securities Exchange Act of 1934 §12(b), (g)
Securities Exchange Act of 1934 §14a-9
Chapter 16: Public Shareholder Activism
Overview
This chapter introduces you to -


various theories explaining the role of shareholders in a public corporation – given the
separation of ownership and control in such corporations
various phenomena in the modern public corporation affecting shareholder activism,
including the prisoner’s dilemma and deretailization
shareholder voting procedures in public corporations (including reimbursement of
expenses and shareholder communications) and the increasing role of institutional
shareholders

the SEC shareholder proposal rule, its operations, and its substantive exclusions
Summary
The main points of the chapter are -




Public shareholders exercise their role by voting on board nominees, board-approved
initiatives, and shareholder proposals
Shareholder activism is becoming increasingly institutionalized with large institutional
investors having the loudest voice, hence control, over the corporation
A corporation may be required to reimburse the expenses of an insurgency proxy vote
o Reimbursement for incumbent directors, if grounded in a policy question
o Reimbursement for a successful insurgency, if voted on by shareholders
o Modern movement toward reimbursement regardless of insurgency outcome
Federal regulations limit corporate free speech to prevent influencing shareholder
voting—depending on the relationship of the speaker to the corporation, such speech
may be considered a proxy solicitation
The shareholder proposal rule, SEC Rule § 14a-8, allows any shareholder who meets the
ownership requirements, and who properly formats his proposal and submits it before the
deadline, to have a proposal included in the company’s proxy materials for a vote at the
shareholders’ annual meeting.
o To be eligible to submit a shareholder proposal, a person must have continuously
held at least 1% or $2,000 worth of the company’s voting shares for at least one
year. The shareholder must then continue to hold the shares and present the
proposal at the meeting.
o The shareholder proposal cannot exceed 500 words, and must be submitted to
the company not less than 120 calendar days before the date of the company’s
last-year proxy statement
o SEC Rule § 14a-8(i) provides thirteen substantive grounds whereby a company
can lawfully exclude a shareholder proposal from its proxy materials.
o If the company fails to include a shareholder proposal in its proxy materials, it
must notify the SEC by filing the proposal and the company’s reasons for
exclusion. If the SEC, upon review, determines that this exclusion is appropriate
it will issue a “no action” letter. If the SEC determines that the exclusion is not
appropriate, it may pursue an enforcement action against the company.
Additional reading
You can see how voting works:

Is corporate voting strained like political voting (see the 2000 presidential election in
Florida)? There are signs the corporate proxy system may not be up to the task of
dealing with custodial ownership, high trading volumes by dispersed owners, and short
selling/derivatives. Is an overhaul necessary to make the system more efficient and
transparent? {more >>>]
Statutes
These statutes are relevant:


Securities Exchange Act of 1934 §14a-1
Securities Exchange Act of 1934 §14a-8
Chapter 17: Shareholder Litigation
Overview
This chapter introduces you to -



the basic right of shareholders to sue and initiate litigation (this is one of the three major
rights of shareholders: vote, sue, sell)
the two basic types of shareholder litigation: derivative and direct
the requirements to qualify as a shareholder plaintiff: adequacy and standing
the policy considerations that arise and make shareholder litigation a controversial issue
Summary
The main points of the chapter are -



Shareholders have a right to sue and initiate shareholder litigation; this type of lawsuit
may be derivative or direct.
o Derivative—the lawsuit is brought by the shareholder on behalf of the corporation
in which he is a stockholder, to assert rights belonging to the corporation.
o Direct—the lawsuit is brought by the shareholder on his own behalf, to assert a
violation of his rights.
There are special considerations for derivative lawsuits that do not apply to direct
lawsuits.
o Demand requirement—in a derivative lawsuit the plaintiff is required, pursuant to
F.R.C.P. 23.1, to “allege with particularity the efforts, if any, made by the plaintiff
to obtain the action plaintiff desires from the directors.” If the court decides that
this demand requirement is not met then the case is dismissed. [Note: pleading
“demand futility” is no longer a valid way of satisfying the demand requirement;
see Aronson]
o SLC (special litigation committee)—a committee formed on behalf of the
corporation to offer a recommendation to the court of how to respond to a
derivative lawsuit. The SLC is made up of independent persons (typically
independent directors not named as parties, as well as hired lawyers and
advisors). More often than not the SLC recommends that the case be dismissed.
o The standard of review for the recommendation that the SLC makes to the court
may be the lenient business judgment rule (Auerbach) or a heightened standard
of review (Zapata).
In order to initiate a shareholder lawsuit, the party must satisfy the adequacy and
standing requirements.
o Adequacy—the plaintiff must be capable of adequately and fairly representing
the interests of the shareholders in a direct lawsuit or the corporation in a
derivative lawsuit.
o Standing—in order to have standing in a lawsuit, a party must have suffered an
injury. In a derivative lawsuit, the injury is alleged on behalf of the corporation,
and standing is limited to those with an equity interest in the corporation, which is
determined on the basis of three factors: the nature of the holding, timing, and
the plaintiff’s countervailing interests.
There are several policy issues that make shareholder litigation a controversial topic:
o
o
o
Agency costs of litigation—the plaintiffs’ attorney typically has a much greater
financial stake than any individual shareholder in the outcome of the litigation,
and collective action problems limit the ability of shareholders to effectively act in
concert.
Challenges of settlements—because plaintiffs’ attorneys typically work on a
contingent fee basis, they may have an incentive to settle rather than go to trial.
In some lawsuits the best interests of the shareholders may be served by going
to trial. Ultimately, it is up to the court to approve the fairness of any settlement.
Attorneys’ fees—the prevailing party in shareholder litigation is typically not
entitled to attorneys’ fees, but when attorneys’ fees are appropriate the attorneys
may have a financial incentive either to settle the case more rapidly or to prolong
the litigation depending upon how this award is calculated.
Additional reading

In April 2013, News Corp. agreed to the largest ever settlement in a derivative lawsuit:
$139 million. The lawsuit alleged that Rupert Murdoch turned a blind eye to criminal
activity within News Corp., and used the corporation to “pursue his quest for power,
control and political gain and to enrich himself and his family members, at the Company’s
and its public shareholders’ expense.”
Rules
These rules are relevant:


F.R.C.P. 23
F.R.C.P. 23.1
Chapter 18: Board Decision Making
Overview
This chapter -



considers the operation of the business judgment rule and justifications for the policy of
judicial abstention
reviews Shlensky v. Wrigley, an iconic case that applied the business judgment rule in
the context of a baseball team’s unprofitable decision
analyzes Smith v. Van Gorkom, a landmark case that addressed the fiduciary duties
owed in the context of a merger decision that was purportedly uninformed
provides an overview of the ways that directors are insulated from personal liability:
exculpation clauses, indemnification, D&O insurance
Summary
The main points of the chapter are --





A board of directors has a fiduciary duty to act in an honest and informed manner, in
good faith and without self dealing to promote the interests of corporation.
Despite this relatively straightforward requirement, directors have powerful defenses to
claims that they violated the duty of care or the duty of loyalty.
Sklensky v. Wrigley illustrates the business judgment rule at work, which protects
directors from liability for business decisions even when those decisions result in losses
to the corporation.
Smith v. Van Gorkom, a landmark case, is essential reading for understanding how
courts assess the actions of a board of directors, particularly with regard to the fiduciary
requirement that a board decision is “informed.”
o DGCL§102(b)(7)—implemented by Delaware legislature in response Smith v.
Van Gorkom, allows corporations to adopt charter provisions to insulate directors
from personal liability for certain decisions.
There are three ways that directors can avoid liability for board decisions:
o Exculpation—many states (including Delaware, see above §102(b)(7)) have
initiated legislation that allows a corporation to absolve directors of monetary
liability for specific types of board decisions.
o Indemnification—the corporation is often allowed to directly pay for monetary
damages that a director is held liable for, or to reimburse the director for his
payment of these damages (this is also the case in Delaware; see §145). There
are three types of indemnification: permissive (the corporation may indemnify the
director), mandatory (the corporation must indemnify the director), and prohibited
(the corporation cannot indemnify the director).
o D&O insurance—the corporation purchases insurance policies to cover any
monetary damages it may owe as a result of prohibited conduct by a
director/officer (for Delaware, see §145(g)).
Additional reading

When News Corp., in April 2013, agreed to the largest ever settlement in a derivative
lawsuit, the entire settlement was entirely covered by D&O insurance. To some
commentators, the fact that the underlying (perhaps egregious) conduct was insured
raised serious issues for insurance companies providing D&O insurance.
Statutes
These statutes are relevant:




MBCA § 8.30
DGCL § 102(b)(7)
MBCA § 2.02(b)(4)
DGCL § 145
Chapter 19: Board Oversight
Overview
This chapter -



introduces the “oversight” role of directors, particularly their responsibility in managing the
financial and regulatory risks of the corporation
presents Francis v. United Jersey Bank, a “classic” case of director oversight in the
context of a somewhat dysfunctional family-run corporation
dissects In re Caremark Litigation, a very important modern case that illustrates the
complexities of director oversight
delves into Stone v. Ritter, a case that helped clarify the meaning of “good faith” action
Summary
The main points of the chapter are -



A corporation’s shareholders delegate the power to manage and direct the corporation’s
affairs to its directors; in turn, the directors delegate some of this power to the officers
and employees of the corporation.
A key question that arises is how much are directors expected to do?
o Standard of conduct—a director is generally expected to act in good faith, and in
a manner that he reasonably believes to be in the best interests of the
corporation. When becoming informed of impending decisions or risks, he is
expected to use the care that a like person in the same position would use.
Another major question is what is the standard that directors required to do, and when
will they be held liable?
o Liability—a director may be held liable for failing to adequately discharge his
responsibility of oversight. This liabilty often arises not because of an affirmative
act, but rather as a result of a failure to act appropriately under the
circumstances.
The application of these principles to the conduct of directors is often very fact specific,
and the case law provides crucial precedents for scenarios involving (wrongful)
delegation, (lack of) attentiveness, and (im)proper receipt of a financial benefit.
Statutes
These statutes are relevant:




MBCA § 8.30
MBCA § 8.31
MBCA § 8.24
Sarbanes-Oxley 404
Chapter 20: Director Conflicts
Overview
This chapter -


provides an overview of the “traditional” duty of loyalty, which arises when a director
enters into a transaction with the corporation and there is a risk of self-dealing
reviews statutory approaches to the duty of loyalty, along with the three factors that these
statutes tend to focus on: board approval, shareholder approval, and fairness
introduces the corporate opportunity doctrine, which forbids a director, officer, or
managerial employee from diverting a business opportunity that “belongs” to the
corporation
Summary
The main points of the chapter are -

Contemporary statutes governing director interested transactions do not make such deals
automatically invalid; rather, these statutes assume that a director may enter into a valid
exchange with the corporation that does not violate the duty of loyalty
o Safe harbor—modern statutes often attempt to create certainty for directors
entering into such transactions that certain actions cannot be successfully
challenged as violating the duty of loyalty. [see MBCA Subchapter F; DGCL
§144]
Director conflict statutes typically focus on three factors to determine if an improper
director conflict exists:
o Fairness—for a potentially self-dealing transaction to be fair, the deal must be
procedurally fair as well as well as substantively fair. Procedural fairness
considers how the transaction was approved, the disclosure given to those
making the decision, the ability of the directors to be objective, and the effect of

shareholder ratification. Substantive fairness often has been distilled to a single
question: “whether the proposition submitted would have commended itself to an
independent corporation.”
o Board approval—a potentially self-dealing transaction must have been approved
by “disinterested” and “independent” directors. A disinterested director is one
who does not receive a material benefit as a result of the challenged transaction
that is greater than what is received by other shareholders. An independent
director is one whose decision did not result from his being controlled by another
director.
o Shareholder approval—a potentially self-dealing transaction must be approved
(or subsequently ratified) by disinterested shareholders, and the corporation must
have disclosed to shareholders the material facts of the transaction and the
director’s personal interest. When the interested directors are also majority
shareholders in the corporation, additional complications will arise.
A director may violate the duty of loyalty through a transaction with a third party, if the
transaction involves a corporate opportunity that “belonged” to the corporation
o Corporate opportunity doctrine—a director, officer, or managerial employee
cannot take a business opportunity for himself that the corporation could
financially undertake, is within the corporation’s line of business, is advantageous
to the corporation, and is one in which the corporation had an interest or
reasonable expectancy.
Additional reading

A recent decision in Illinois offers a clear-cut example of the corporate opportunity
doctrine at work. The President of a steel company, Star Forge, secretly entered into
employment and sales commission agreements with rival steel companies while still
working for the company. Star Forge filed a lawsuit alleging that this was a subversion of
corporate opportunities that belonged to the corporation. The trial court agreed, granting
summary judgment to Star Forge and assessing $700,000 in damages. This decision
was affirmed on appeal.
Statutes
These statutes are relevant:




MBCA Subchapter F
ALI Principles - Section 5.05 (Corporate Opportunities)
DGCL § 144
DGCL § 122(17)
Chapter 21: Executive Compensation
Overview
This chapter --




provides an overview of the methods by which executives are compensated
tells the story of one case of executive compensation - Dennis Koslowsky of Tyco
International (be forewarned, the story ends sadly for Mr. Koslowsky)
considers the federal and state law that applies to executive compensation
describes the Disney litigation in which the Delaware courts outlined a duty of "good faith"
in board pay-setting decisions (the story ends happily for Mr. Ovitz, and perhaps sadly for
Disney shareholders)
Summary
The main points of the chapter are -



Executive compensation presents an inherent conflict of interest for shareholders: they
want corporate managers to be incentivized to work hard to maximize profits, but a higher
level of executive compensation necessarily reduces the cash that can be distributed to
shareholders.
The high level of executive compensation in relationship to average worker pay raises
several important policy questions:
o What is “fair” pay for executives, and in what way should stock options be used
to incentivize performance?
o What process should be used to determine executive pay?
Both federal and state law governs executive compensation
o Federal law previously focused primarily on the disclosure of executive pay in
public companies, but more recently has shifted focus to creating substantive
rights for shareholders seeking to challenge executive pay. Federal law now
prohibits public companies from giving loans to directors and executive officers,
requires the disgorgement of executive pay when an executive misstated the
company’s performance, allows shareholders the right to vote on “golden
parachute” packages, requires the “clawback” of executive compensation for the
three previous years if a public company is required to restate its financials, and
requires a “say on pay” vote whereby shareholders in a public company have the
right to an advisory vote on executive compensation.
o State law focuses primarily on the process for setting executive compensation,
however the business judgment rule applies. When executive compensation is
judicial reviewed, the standards of waste, care, and fairness govern the analysis.
Despite these checks on excessive compensation, the saga regarding Michael Ovitz’s
severance package (Disney litigation) illustrates that executive compensation may be
legally acceptable even when both the process for setting it and the substantive amount
are less than ideal.
Additional reading

Executive compensation continues to soar, as a recent NY Times article titled “Executive
Pay: Invasion of the Supersalaries” describes.
Statutes
These statutes are relevant:





26 U.S.C. § 162(m)
Securities Exchange Act § 13(k)
Sarbanes-Oxley § 402
Sarbanes-Oxley § 304
15 U.S.C. § 7243
Chapter 23: Securities Markets
Overview
This chapter -


provides an overview of U.S. securities markets and the regulatory framework under
federal law
describes the federal registration requirements for raising capital on public securities
markets
outlines the exemptions from registration that permit private placements and small
securities offerings
Summary
The main points of the chapter are -



Market efficiency is an important concept behind the regulation of securities markets: the
prices of securities will be most accurate when correct information about a company is
rapidly disseminated, and false or misleading information is quickly dispelled.
In part because of this emphasis on market efficiency, misrepresentations in securities
disclosures may lead to legal liability under the ’33 Act
In order to raise capital on the public securities markets (e.g. through an IPO) certain
federal registration requirements are necessary, including prospectus disclosures and
proxy voting. The ’33 Act § 5 offers three key protections:
 No person can offer a security unless the registration statement for that security
has been filed with the SEC
 Sale of a security is allowed only after the registration statement has become
effective
 A “statutory prospectus”—which includes the most important information in the
registration statement—must be delivered to the buyer before or when the
security is sold.
Certain securities are exempt from registration under the ’33 Act § 3, 4. The following are
major registration exemptions:
 Stock trading—under ’33 Act § 4(1), registration is not required for “transactions
by any person other than the issuer, underwriter, or dealer.” This allows other
parties, including the general public, to trade in previously issued securities.
 Statutory private placement—under ’33 Act § 4(2), registration is not required for
“transactions by an issuer not involving any public offering.” This exemption
hinges on whether the potential purchasers are sufficiently sophisticated,
whether the investor has access to all material investment information, whether
the issuer has actually distributed information to offerees, whether the offerees
are few in number, and whether the offering looks like a public offering.



Intrastate offering-- under ’33 Act § 3(a)(11), registration is not required for any
security that is part of an issue offered and sold exclusively to “persons resident
within” one state by a corporation “incorporated by and doing business within”
that state.
Small offering and private placement—under Regulations A and D, offerings may
either be subject to no registration or only a “mini-registration” as determined
under Rules 504, 505, and 506.
Resale of securities issued pursuant to an exemption—under Rule 147, the
resale of securities to nonresidents (not covered under § 3(a)(11)) are permitted
after the original distribution to residents has “come to rest” in the hands of instate residents.
Additional reading

How do the securities laws interact with new forms of currency, like bitcoin? A Federal
judge ruled in 2013 that bitcoin is a currency, like cash, subject to U.S. securities laws.
The SEC subsequently charged the co-owner of two bitcoin websites with violating ’33
Act § 5(a) and 5(c) because he published prospectuses on the internet soliciting investors
without registering these offerings with the SEC.
Statutes
These statutes are relevant:


’33 Act § 5
Reg D
Chapter 24: Securities Fraud Class Actions
Overview
This chapter -

describes Securities Fraud Class Actions, explaining their statutory basis and comparing
them to state fiduciary derivative suits
lays out the Supreme Court case law and the various congressional enactments,
particularly the Private Securities Litigation Reform Act of 1995
Summary
The main points of the chapter are -
The Securities Exchange Act of 1934 § 10(b) prohibits fraud in connection with securities
trading, and Rule 10b-5, promulgated under § 10(b), compels honest and full disclosure
in all securities-related communications.


The elements of Rule 10b-5 action are judge made, although the Private Securities
Litigation Reform Act of 1995 (PLSRA) tightened some of the procedures and pleading
standards in securities fraud actions.
A private securities fraud class action (SFCA) requires that the plaintiff establish the
following basic elements:
o materially false or misleading statements by the defendant
o made with an intent to deceive (scienter)
o upon which the plaintiff relied
o causing losses to the plaintiff
Additional reading

In June 2014, SCOTUS decided Halliburton v. Erica P. John Fund and made it more
difficult for plaintiffs to successfully bring a securities fraud case. The court held that
defendants can, at the stage of class certification, rebut the plaintiffs’ presumption of
“reliance” by showing that an alleged misrepresentation did not affect the stock price.
Statutes
These statutes are relevant:


Securities Exchange Act of 1934 § 10(b)
Securities Exchange Act of 1934 § 21(D)(b)(2)
Daily Thoughts
A man walks into a lawyer's office and inquires about the rates.
"Fifty dollars for three questions,
"replies the lawyer.
"Isn't that awfully steep?" asks the man.
"Yes," the lawyer replies, "and
what's your third question?"
A lawyer awakes from surgery, and asks: "Why are all the blinds drawn?" The nurse answers:
"There's a fire across the street, and we didn't want you to think you had died."
What is the difference between a catfish and a lawyer? One's a slimy scum-sucking bottomdwelling scavenger, and the other is a fish.
Chapter 25: Insider Trading
Overview
This chapter -



provides a primer on insider trading, describing both classic insider trading and
misappropriation
reviews the duties of insiders who engage in securities trading based on their relationship
with the corporation, the disclosing party, and the receiving party
tracks the development of the federal regulatory regime and briefly looks at the rules
under state corporate law
analyzes the triumvirate of federal cases (Chiarella, Dirks, O'Hagan) that form the
foundation for modern U.S. insider trading law
Summary
The main points of the chapter are -






Insider trading is illegal and policy considerations concerning fairness, information
efficiency, and theft of company information support the law
The federal regulatory regime governing insider trading encompasses both classic insider
trading and misappropriation
The majority rule, as illustrated by Goodwin v. Agassiz, is that directors and officers have
no duty to disclose material nonpublic information when they trade company securities in
an open market
Under Rule 10b-5, insiders of a corporation have a duty of trust and confidence that will
give rise to liability if the wrong information is disclosed to the wrong party
Chiarella illustrates the “classical theory” of insider trading law: a violation occurs when
an individual has a duty to disclose information as a result of a fiduciary duty or a
“relationship of trust and confidence” between parties to a transaction
As the Supreme Court held in Dirks, an outsider to a transaction—such as an
underwriter, accountant, attorney, or consultant—who receives nonpublic corporate
information with the expectation that it will be kept confidential violates the law when he
trades on this information. This is known as tipper-tippee liability.
Insider trading can occur even when the person receiving the information owes no duty to
the person with whom he trades. As the Supreme Court stated in O’Hagan, trading on the
basis of material nonpublic information obtained by a person in any position of trust and
confidence can constitute a Rule 10b-5 violation under the “misappropriation theory.”
Additional reading
You can see information about insider trading:

In a recent and particularly unpalatable insider trading case, a managing clerk at the law
firm Simpson Thacher & Bartlett and a stockbroker were arrested for insider trading. The
clerk routinely stole tips about upcoming M&A transactions at Simpson Thacher, and then
met with a middleman at a bar or restaurant to pass the information along. The
middleman would then meet the stockbroker near the clock in Grand Central Station to
convey the information. Concerned about being found out, the middleman typically would
write the stock ticker symbol of the relevant company on a napkin or post it note, and
then display it to the stockbroker. After the stock broker had memorized the symbol, the
middleman would place the napkin/note in his mouth, and chew and swallow it to destroy
the evidence.
Statutes
These statutes are relevant:

Securities Exchange Act of 1934 § 10b-5
Chapter 26: Sale of Control
Overview
This chapter -



describes the nature of control in the corporation and how it can be sold
looks at the duty of a controller to investigate a buyer as a potential looter
considers when a selling controller's control premium must be shared with non-controlling
shareholders
summarizes the rules for a buyer installing his own board of directors after a sale of
control
Summary
The main points of the chapter are -

Shareholders have a right to sell their shares in a corporation (this is one of the three
major rights of shareholders: vote, sue, sell), however there are important limitations on
controlling shareholders when they sell their shares.
Controlling shares in a corporation are more valuable than non-control shares (and
typically sell for a higher price, called a “control premium”) because they allow the holder
to elect the board of directors, and to decide business strategy, executive pay, and
dividend policy.

A party that owns controlling shares has a fiduciary duty to investigate before selling his
controlling position if he has been put on notice that the purchaser is deceptive or
untruthful, and thus it is likely that his control will harm the corporation.

Most courts have held that a controlling shareholder can sell his controlling interest (even
when the corporation has assets of particular value to the buyer) without sharing the
control premium with non-controlling shareholders or the corporation. [see Perlman v.
Feldmann to understand the evolution of this rule.]

A party that purchases controlling shares in a company does not have immediate control,
because control of the corporation’s business is vested in the board of directors, who are
elected by the shareholders. Directors are prohibited from selling their corporate office,
however it is legal for the seller and buyer to agree on resignations on the existing board
of directors. [see Essex Universal Corp. v. Yates].
Daily Thoughts
The Wisdom of Yogi Berra:
“You can observe a lot by just watching.”
“If you come to a fork in the road, take it.”
“Always go to other people's funerals, otherwise they won't come to yours.”
More of the Wisdom of Homer Simpson:
“Getting out of jury duty is easy. The trick is to say you're prejudiced against all races.”
"The code of the schoolyard, Marge! The rules that teach a boy to be a man. Let's see. Don't
tattle. Always make fun of those different from you. Never say anything, unless you're sure
everyone feels exactly the same way you do."
“Kids, you tried your best and you failed miserably. The lesson is: never try.”
Chapter 27: Antitakeover Devices
Overview
This chapter -


provides an overview of antitakeover devices used to protect a corporation from a hostile
takeover
considers competing arguments for and against the use of antitakeover devices in the
corporate landscape
summarizes the judicial review of antitakeover devices under the business judgment rule,
Unocal, and Revlon
Summary
The main points of the chapter are -


There are numerous ways that directors and officers can protect a corporation from
unwanted suitors. The following are some of the most common antitakeover devices:
o “Staggered” board—the corporation spaces the election of directors so that only
a portion are elected each year, and thus a potential bidder must wait two
election cycles to obtain control of the board.
o “Poison pill” (or “shareholder rights plan”)—the corporation issues additional
“rights” that attach to its outstanding shares. These new rights cannot be traded
separately and initially have terms that give them little value. However, the rights
plan specifies a “triggering” event—typically when a potential acquirer buys a
specified portion of the corporation’s shares—which changes the rights to give
the holder the option to buy additional shares at a low price. When these
shareholders exercise the option, following a “triggering” event, the acquirer’s
position is diluted.
o Share repurchase—directors authorize the repurchase of shares, either by the
corporation directly or through an employee stock ownership plan or pension
plan, in response to action by an unwanted acquirer.
o Lock-up—directors agree to a transaction with a third-party to sell some asset of
the company in order to discourage an unwanted acquirer who is particularly
interested in the company because of this asset.
Antitakeover devices raise fundamental policy questions surrounding the potential conflict
of interest between directors and shareholders: although directors are in a strong position
to evaluate the costs and benefits of a potential acquisition and to determine when this is
not ideal, shareholders want to maximize their gains and often are in favor of any deal
where they can sell shares at a premium.
Courts have recognized this potential conflict of interest between shareholders and
directors, and have fashioned three approaches in evaluating the appropriateness of a
board’s response to a perceived takeover threat:
o Under the business judgment rule, a transaction approved by a majority of
independent, disinterested directors generally receives BJR protection, a judicial
presumption that protects the decision from review.
o Although decisions by a board of directors are given significant leeway, the
board’s response to a perceived takeover threat must be proportional to the
perceived threat. Unocal is the leading case on this issue and sets out a twopronged “proportionality” test to determine: (1) whether the board had reasonable
grounds for believing a threat to the corporation existed; and (2) whether the
defensive measures taken were reasonable in relation to the perceived threat.
o
When a corporation is up “for sale” and such a sale is inevitable, the duties of the
board of directors shift under Revlon: rather than protecting the corporation
against the overtures of unwanted acquirers, the board is required to take steps
to maximize the price paid for the company.
Additional reading

Will a “poison pill” reduce wrinkles for directors of a target corporation? Only sometimes.
In April 2014, Valeant, a pharmaceutical company, teamed up with William A. Ackman, a
hedge fund manager and activist investor, in an attempt to acquire Allergan, the maker of
Botox. This was the first time in history that an activist investor and a company teamed
up for a bid, and the C.E.O. of Valeant directly informed Ackman of its intention to acquire
Allergan. Allergan did not welcome the acquisition, and mounted a formidable defense: it
implemented a “poison pill” and managed to halt the acquisition. On June 18, 2014
Valeant made an unsuccessful tender offer for Allergan. Allergan has so far held off the
unwanted advances of Valeant, but the fight is not over yet. On August 1, 2014, Allergan
filed a lawsuit against Valeant and Ackman, alleging that by coordinating their stock
purchasing efforts they engaged in insider trading and that Ackman should be forced to
disgorge the Allergan shares that he owns. The court will consider Allergan’s argument
that Valeant and Ackman violated SEC Rule 14e-3, which states that “[i]f any person has
taken a substantial step or steps to commence, or has commenced, a tender offer” it will
be considered “a fraudulent, deceptive, or manipulative act [for] any officer, director,
partner or employee or any other person acting on behalf of the offering person or such
issuer, to purchase or sell” stock.
Statutes
These statutes are relevant:



DGCL § 141
DGCL § 157
DGCL § 160
Chapter 28: Deal Protection
Overview
This chapter -


introduces you to deal protection devices, which are contractual arrangements that
“protect” a deal by motivating the parties to ensure that the deal goes through
provides an introduction to several common deal protection devices
offers a tour through the complicated case law surrounding deal protection devices, with
the key decisions of Omnicare, Paramount v. Time, Paramount v. QVC, Chesapeake v.
Shore, and Lyondell v. Ryan
Summary
The main points of the chapter are -





Deal protection devices have the opposite effect of antitakeover devices: rather than
thwarting takeover bids by an unwanted acquirer, they attempt to ensure that a takeover
will be completed with a wanted acquirer. A major reason for including a deal protection
device is that negotiating an acquisition is expensive, and both parties have an incentive
to make the deal work.
The following are common deal protection devices:
o Termination fee—the target corporation agrees to pay a pre-agreed amount
(often between 1-5% of the share price) to the acquirer if it terminates the deal.
o Lock-up—the acquirer is given the right to buy certain assets of the target at a
bargain price whether the deal goes through or not, thus preventing the target
from striking a better deal for these assets.
o No-shop—the target is prohibited from soliciting other acquirers during a
specified period of time.
o Voting agreement—the board of directors of the target obtains an early
agreement from the shareholders to vote in favor of the merger.
Although it is not the majority view, a court may conclude, as in Omnicare, Inc. v. NCS
Healthcare, Inc. that deal protection devices are invalid because they are so absolute as
to preclude the board of directors from carrying out its fiduciary responsibilities.
Paramount v. Time illustrates that deal protection devices may be in direct conflict with a
board’s Revlon duties, raising serious issues of fiduciary duty.
When a deal protection device interferes with the fundamental right of shareholders to
vote on a transaction, as in Chesapeake Corp. v. Shore, it must have a “compelling
justification” in order to be upheld.
Nonetheless, Lyondell Chem. Co. v. Walter E. Ryan, Jr. illustrates the typically deferential
approach of courts to deal protection devices.