The Worst Advance Notice

Bylaw Terms

...aren't even the ones in the news lately.

We've long followed developments in company bylaws that seek to block activist investing. Think of bylaws as the contract between the company and its shareholders. We read the contract early and often as we consider and pursue activist situations.

Last week, Politan Capital sued portfolio company Masimo Corporation (MASI) over recent amendments to its bylaws. Politan calls these changes "draconian" and an "existential threat" to all activists' efforts. Others, including Matt Levine at Bloomberg and law professors Lawrence Cunningham and John Coffee, mostly agree.

The bylaws at MASI do break new ground in curtailing activist investors. Yet, based on a casual review of other companies' bylaws, they don't represent the worst of it. The MASI bylaws affect activist and nominee disclosures. Others we found restrict what a duly-elected director can say and do to represent investor interests, and enforce these restrictions harshly.

A brief taxonomy of restrictive bylaws

We can think of a few categories of bylaw terms:

• Disclosure: what an activist and its nominees disclose to the company as a condition of standing for election
• Conduct: what a director can and cannot do while serving on a BoD
• Enforcement: how the company enforces the required conduct.

Most of these terms show up as part of the advance notice provisions. These require an activist to notify the company of its intent to nominate one or more candidates at a shareholder meeting. The company usually requires this notice a few months before the expected meeting date. This gives the company plenty of warning, so it can preempt whatever message an activist plans to deliver to shareholders.

In addition to many months' notice, the company also requires extensive disclosure as part of the notice. These include personal and business background, nature and extent of an activist's investment in the company, and many other trivial and immaterial details. This frequently takes the form of an extensive questionnaire, sometimes comprising hundreds of pages. 

Disclosure has two goals. It dissuades all but the most determined activist from going through with a nomination. It also seeks to trip up an activist that misses a detail, and then allow the company to disqualify a nominee.

MASI imposes new disclosures

Within this framework, MASI requires some disclosures not seen before:

• An activist's investors, say in its funds
• An activist's collaborators, broadly defined to include just about anyone the activist has talked to in the past two years, including family members, with the required (extensive personal and business) disclosures applying to these collaborators
• Company shareholders "known" to the activist to "support" its nominations
• An activist's past nominations or proposals at other companies in the past three years, even if they did not disclose them publicly
• An activist's plans to nominate directors at other companies in the next year.

Politan sued MASI over these and other bylaw terms. It claims they illegally limit its legitimate efforts to exercise its proper rights as a shareholder to nominate directors.

It gets worse

While nosing around bylaw amendments that respond to universal proxy, we read a number whose problems go beyond intrusive and tricky disclosure. Bylaws for United Airlines Holdings (UAH) exemplify this. We looked at two notable terms: nominees must follow company policies, and resign from the BoD if they violate one or another policy. These follow the latter two categories noted above.

As a condition of standing for nomination, a director agrees to follow all company policies:

...comply with all applicable rules of any securities exchanges upon which the Corporation’s securities are listed, the Restated Certificate, these Restated Bylaws, all applicable publicly disclosed corporate governance, ethics, conflict of interest, confidentiality, stock ownership and trading policies and all other guidelines and policies of the Corporation generally applicable to Directors... 

A director further agrees to resign if they violate these policies:

...[a nominee] will tender his or her resignation as a Director if the Board determines that such Proposed Nominee failed to comply with the provisions of this Section 2.10(a)(3)(B)(iv) in all material respects...

(Amended and Restated Bylaws, Article 2.10 (a)(3)(B)(iv), September 25, 2022; emphasis ours)

We find both terms quite troubling. We have in mind policies that severely limit directors from communicating with shareholders. Many companies require all communication to work through company executives. Directors have no way to convey what they hear at the BoD, and to solicit feedback from shareholders about the company.

Even worse, companies can make policies pertaining to anything. If a company like MASI will adopt abusive disclosure terms, then we can easily see them adopting all manner of similar corporate policies. They could require directors to attend excessive meetings, obtain unnecessary credentials, or wash the CEO's car.

The bylaws then enforce these through mandatory resignation. We expect UAH and others that have this bylaw term obtain an advance conditional resignation letter from the director. It's probably part of the questionnaire. 

Also, we're talking about duly-elected directors here. We can accept (but don't like) that a director agrees to these terms as part of a settlement of a proxy contest, or otherwise accepts an invitation to join a BoD. These terms become part of the negotiation between the company and an activist.

Consider a director that wins an election, though. A company with these bylaw terms can pretty much remove directors at its will. It would approve a new policy that the director would violate, then accept the resignation that it required as a condition to even stand for election. 

Sure, unnecessary and intrusive disclosure is an expensive hassle. We find limits on what a duly-elected director can do to represent shareholder interests, including automatic enforcement at the discretion of company leadership, much worse.