Fee Shifting Bylaws and the Reaction of Institutional Investors (Part 3)

We are discussing letters written by a number of institutional investors to proxy advisory firms and policymakers in Delaware. Copies of the letters can be found here.

More than influence state law, the letters from investors sought to increase the consequences of fee shifting bylaws in the proxy process. Letters were written to ISS and Glass Lewis noting a number of concerns. These included an absence of any meaningful limits on the breadth of fee shifting bylaws. See Id. ("In fact, if a unilaterally adopted bylaw can be used to target stockholder litigants, then there may be no distinction to prevent boards from using bylaws to impose fee shifting against stockholders who merely pursue proxy solicitations against the board.").

In addition, fee shifting bylaws provided a financial penalty even for some meritorious cases. Id. ("Allowing corporate directors to require stockholders to bear the expenses a corporation may incur in fighting stockholder litigation, even if the suit has merit, effectively eliminates the ability of stockholders to look to Delaware courts to protect their rights as the owners of corporations.").  

The letters recommended that the proxy solicitation firms formulate an explicit policy addressing these bylaws. 

• We believe that it would be appropriate for ISS to adopt a policy recommending that shareholders vote against the reelection of any director who uses bylaw amendments as a weapon to eliminate stockholder rights. We believe such a policy would serve as a strong deterrent to discourage corporate boards from using bylaw amendments to remove accountability over directors render their fiduciary obligations illusory.

A larger role for ISS and Glass Lewis could have broad impact. Directors are, for the most part, elected under the plurality system. Unless shareholders run a competing slate of directors, the management nominated candidates always win. As a result, increasing the number of negative votes will not prevent reelection.  

Most large companies have in place a majority vote policy. These policies typically require that directors who fail to receive a majority submit a letter of resignation. Since boards are for the most part unlikely to accept these resignations, shareholders will not be able to defeat directors even at companies with majority vote provisions.

Nonetheless, a policy encouraging "no" votes with respect to directors who "uses bylaw amendments as a weapon to eliminate shareholder rights" would, at a minimum, be uncomfortable for the board, potentially impair communications with shareholders, and alienate long term shareholders. Companies have an incentive to avoid this result.  

Moreover, the approach has worked in the past. When activist shareholders proposed paying their nominees additional compensation based upon performance, some companies adopted bylaws designed to prohibit the practice. In 2013, ISS recommended that shareholders vote against three directors that approved a bylaw restricting director payment from anyone other than the company. The directors were elected "by an unusually low margin."

The risk of a "just say no" campaign and shareholder opposition to director candidates, therefore, provides boards with at least some disincentive to adopt fee shifting bylaws.