Friday, December 1, 2023
This week, we had two interesting, and very different, decisions on the validity of anti-activist bylaws.
The first decision, out of Delaware, upheld certain advance notice bylaws in the context of a motion for a preliminary injunction, while the second, from the Second Circuit, rejected control share acquisition bylaws adopted by a closed-end mutual fund.
The first decision, Paragon Technologies v. Cryan, concerned Paragon’s activist attack on penny stock Ocean Powers Technology (OPT). After Paragon expressed interest, OPT adopted an advance notice bylaw requiring director nominees offer a wealth of information, including any plans that would be required to be disclosed on a 13D, any business or personal interests that could create conflicts between the nominees and OPT, and any circumstances that could delay a nominee receiving security clearance, while simultaneously adopting a NOL pill (for more on those, read Christine Hurt).
Paragon submitted some documents in connection with the bylaw, but the “plans” only said it would “fix OPT.” OPT identified numerous deficiencies in Paragon’s submission, Paragon submitted more information including that its plans were to reduce expenses and focus on industry growth. Long story short: OPT kept finding deficiencies to complain about, and ultimately Paragon’s nominees were rejected. Paragon had also requested an exemption from the pill, which was denied.
On Paragon’s motion for a preliminary injunction ordering that its nominees be permitted to stand for election, and for relief from the pill, VC Will concluded that neither side had covered itself in glory. She agreed that OPT very possibly had nitpicked Paragon’s application, and some of its demands – like the security clearance thing – were vague and potentially unnecessary. But she also found that Paragon had deleted certain text messages, which contributed to her finding that the record was inconclusive as to whether Paragon had complied with even reasonable bylaws. Like, it might have had plans that were not disclosed; there were discussions among Paragon personnel about a stock-for-stock upside down merger with Paragon. Like, there was the possibility that such a merger would also have had to have been disclosed as a potential conflict. Like, even if the security clearance demand was vague, on this record, Will could not be sure that Paragon had been genuinely confused. And though the timing of the NOL pill was certainly suspicious, the OPT Board’s tax advisor had pointed out that there was a real financial risk to OPT if it granted Paragon’s exemption request.
Given these factual disputes, she concluded that Paragon had not met its burden of proof that it was entitled to an injunction suspending operation of the bylaw and the pill.
I admit, I’m a bit uncomfortable with this holding, because it seems to me that with these kinds of bylaws, it will be very easy for boards to create factual “disputes” about whether all of an activist’s plans were disclosed, or whether there was some undisclosed conflict lurking somewhere, or whether a bylaw really was vague in application, and with those factual disputes in hand, stave off a proxy challenge for at least another year, which may render it uneconomical for an activist to even litigate the bylaw issues in the first place. Perhaps the board’s actual conduct – evasiveness and foot-dragging when addressing requests for clarification – should carry more weight. But I don’t want to overstate; deleted text messages were a real issue, Paragon’s first 13D disclosures were laughable, and Will suggested that she might have looked more favorably on a different request for relief, such as, delay of the annual meeting until trial on Paragon’s claims that OPT breached its duties with respect to the bylaw and the pill. Still, I do think there needs to be more work on how advance bylaws function to undermine activists’ strategies and to what extent that’s good – or at least acceptable – or bad, and unacceptable. (If that paper’s been written, point me to it!)
But then we come to the Second Circuit’s decision in Saba Cap. CEF Opportunities 1, Ltd., Saba Cap. Mgmt., L.P. v. Nuveen. Saba launched an activist attack on a Nuveen closed-end fund, and Nuveen passed a control share acquisition bylaw – any shares Saba acquired in excess of 10% would lose their voting rights, unless the remaining shareholders voted to restore them.
The Second Circuit held that the bylaw violated the Investment Company Act’s requirement that all shares have equal votes. Per the court:
Read together, these two provisions of the ICA control. The first provision requires that all shares of stock must be “voting stock” and have “equal voting rights.” Id. § 80a-18(i). The second defines an umbrella term, “voting security,” as one “presently entitling” the owner to vote. Id. § 80a-2(a)(42). The language is plain and unambiguous. In addition to requiring that all investment company stock be voting stock, the statute defines it with reference to its function—that it “presently entitles” the owner to vote it. Id. § 80a-2(a)(42).
Nuveen’s Amendment violates this provision because under it, if an owner of Nuveen stock cannot “presently” vote their stock, the stock loses its function and is not “voting” stock. The Amendment also violates Section 80a-18(i) because it deprives some shares of voting power but not others—contrary to the provision’sguarantee of “equal voting rights.” Id. § 80a-18(i).
The court distinguished Delaware decisions as being about, you know, Delaware, and noted that poison pills – if permissible at all, which the court would not say definitively – at least are different in that they distinguish shareholders’ economic interests, not the voting rights of the shares. The court repeatedly made somewhat derisive references to Nuveen’s claim that the bylaws were intended to “limit the risk that the [f]und will become subject to undue influence by opportunistic traders pursuing short-term agendas adverse to the best interests of the [f]und and its long term shareholders,” obviously believing such arguments to be irrelevant to the statutory provisions at issue.
What do I find interesting in all this?
First, it is more evidence for one of my recurring themes, namely, that corporate governance is not an exercise in private ordering, but that the hand of the state is now less visible in operating companies than it is in regulation of investors. Corporate organization may carry the patina of private ordering, but the levers of governance are held by institutional investors who are subject to far more intrusive regulations than Delaware ever dreamed of imposing on companies themselves.
Second, Delaware would almost certainly have accepted Nuveen’s claim to be protecting itself against Saba’s desire to “alter investment strategies away from long-term investments, all to turn a ‘quick profit,’” while the Second Circuit nearly laughed the argument out of court. And that’s interesting because Delaware’s invocation of “long termism” has often been interpreted as a sub rosa grant of permission for corporate managers to consider stakeholder interests instead of shareholder ones. I.e., Delaware would never say so explicitly, but every time it permitted directors to fend off a hostile takeover to protect company “long term” interests, it functionally was permitting directors to adopt a stakeholder model of governance.
The Investment Company Act, according to the Second Circuit, grants no such permission. Shareholder primacy reigns supreme. Which means our tightly federally regulated investors are engineered for pure profit seeking without regard for other concerns. Federal law doesn’t contain the “give” of Delaware law, and that’s an aspect of governmental choice, as well.