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Bitter Bar Bylaws Battle Brewing

Ok, it's not bitter and more debate than battle. Still, two prominent law firms disagreed last week about how BoDs should amend company bylaws in response to the new SEC universal proxy card (UPC) rules. Here, we parse the arguments from BoD attorneys Paul Hastings and Sidley & Austin, and learn some hard truths about what activists confront today.

Right away, we observe a couple of things:

  • The bylaw amendments in question have nothing to do with the actual UPC rules. Instead, companies used routine, conforming bylaw amendments as a pretense for sneaking in more onerous terms around now-standard but still-objectionable advance notice provisions.
  • The firms debate what, exactly, companies can get away with in using restrictions in advance notice terms to block activist investors. Yet, everyone fails to ask how these new terms affect activist investors, company shareholders, or financial markets.

Paul Hastings Says The Quiet Part Out Loud

The affair started this past summer, as companies pondered how to respond to the new UPC rules. Law firms flocked to advise them, and settled on updating and revising bylaws. As it turns out, the bylaw updates that pertain directly to UPC seem relatively harmless.

Companies have used UPC updates as an opportunity to screw down other bylaw terms. We learn of these updates mostly through quiet company SEC filings, with about 80 or so companies filing bylaw amendments pertaining to"universal proxy" so far in 2022.

One law firm, Paul Hastings, says the quiet part out loud. Its blog post from a few months ago recommends a range of bylaw changes that will "...put corporate boards and management in a better position to react and inform shareholders regarding [ESG] activist director contests." The post includes a sample bylaw section that goes way beyond UPC. It features several new, extensive disclosures pertaining to an activist fund's investors, contacts with other shareholders, and past and future activist projects at other companies.

Sidley & Austin Pushes Back

These bylaw amendments have started to attract attention:

  • Law professors John Coffee and Lawrence Cunningham critique the new non-UPC terms
  • Activist fund Politan sued portfolio company and Paul Hastings client MASI over these terms
  • Activist attorney Olshan warned BoDs against using UPC bylaw amendments as a pretense for tightening advance notice terms.

BoD attorney Sidley & Austin also commented in a client memo last week. It thinks these terms represent "several of the most aggressive advance notice bylaw provisions considered (and previously dismissed) by shareholder activism defense legal practitioners." Sidley likens the Paul Hastings suggestions as "flying close to the sun", evoking the Icarus metaphor.

Specifically, Sidley questions some of the additional disclosures that Paul Hastings outlines:

  • Disclosure of an activist's fund investors "goes well beyond the vast majority of bylaws that relate to this topic."
  • For disclosure of past and future activist projects at other companies, it "is ... more challenging to argue the relevance of an activist’s future plans at other companies with no relationship to the company or its industry."

It cautions, "[W]hen companies adopt these types of bylaws...they run a risk of undermining reasonable and appropriate advance notice bylaws."

We quibble with some of Sidley's claims, and then raise a basic objection to the whole thing.

  • Sidley: "There is little debate in corporate America over the principle that advance notice bylaws fulfill a valid and reasonable purpose." There is plenty of debate over the principle and also the specifics, of course not in boardrooms but in the wider investment community; just see above for some recent arguments.
  • And: "At most companies, employees...submit applications...to be hired. It stands to reason that candidates for the board of directors...should provide fulsome information to the company and its shareholders..." Directors are hardly employees, and it diminishes directors' role and compromises the principal-agent relationship to think of the nomination process as an employment interview.

Broadly, Sidley essentially argues that BoDs have a good thing these days with advance notice bylaws. Companies learn of proxy contests months ahead of time, and can get to shareholders long before the activist can start to make its case. An activist already discloses abundant information that a company can use against it. Rather than asking what timing and disclosure makes sense for everyone, Sidley cautions: let's not blow it with overreach.

The Debate We Really Need

Advance notice terms in company bylaws serve no practical purpose other than to warn BoDs about an activist situation. They do virtually nothing for voting shareholders beyond what the SEC already requires from activists, or what shareholders themselves can easily demand from both activists and the company.

The SEC already has an extensive disclosure structure in proxy solicitation rules. The SEC anticipated the need for disclosure in its UPC rules. These provide ample time for shareholders to learn about activist and company nominees in abundant detail.

Shareholders that want more or different information can demand it. These days, shareholders voting in a proxy contest know where to ask for more, better, and more timely information from the activist and the company. A company or activist that fails to provide that information risks losing that election.

What activists, companies, and shareholders can really use is a debate about what information shareholders need to cast an informed vote for the BoD. Alas, what we get is a squabble about how to make life harder for investors without attracting unnecessary attention from the Delaware Chancery Court.

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You can find other useful resources at the TAI website, including our research on "Effective Activism", our white paper with the basics on activist investing, and our guides on exempt solicitationconsent solicitation, and special shareholder meetings.
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Michael R. Levin