Article New York Law Journal

Shareholders at the Door

Rights plans are the primary mechanism that most public companies use to manage takeover activity. No hostile tender offer has ever been completed where the board of the target has kept a rights plan in place. Virtually all hostile tender offers that have succeeded against targets with rights plans have done so because the target's directors have ultimately concluded that their fiduciary duties compel them to allow the offer to proceed and thus to redeem the rights plan.

Consequently, the primary effect of rights plans is to give the board of a target of a hostile takeover bargaining leverage in seeking to obtain better price and other terms from the hostile bidder, as well as time to negotiate with "white knights" and explore other strategic alternatives.

In recent years one of the most common proposals put forth by shareholder activists for consideration at annual shareholders meetings has concerned the right of shareholders to approve the adoption, rescission or amendment to rights plans [so called "poison pills"]. Most of these proposals take the form of a precatory [non-binding] shareholder proposal to require the company to obtain prior shareholder approval, or subsequent shareholder ratification, of any rights plan.1

The number of such proposals has increased considerably in recent years. In 2003 alone, there were over 100 submitted to shareholders, an increase of 194 percent since 2001. These proposals have also received a consistently high degree of support from shareholders. The poison pill proposals submitted to shareholders have been approved by an average of 42.6 percent, 42.2 percent, 41.3 percent and 45.0 percent of shares outstanding, and an average 57.2 percent, 58.8 percent, 57.8 percent and 61.0 percent of the votes cast for these proposals, in 2001, 2002, 2003 and 2004 to date,2 respectively.3

With the increased focus on corporate governance issues, precatory proposals regarding rights plans present a serious corporate governance issue for a board of directors. The way in which a board responds to these proposals may have serious implications for shareholder relations, relations with the broader investment community and possibly the stock price of the company.  Most leading "shareholder rights" organizations have taken relatively consistent positions with respect to rights plans. Below is a summary of the positions taken with respect to rights plans by selected prominent shareholder rights organizations.


The Organizations' Views


A. Council of Institutional Investors.

§ The Council of Institutional Investors' Core Principles urge that rights plans be approved by a majority of a company's outstanding shares.4

B. Institutional Shareholder Services.

§ Votes regarding management proposals to ratify a poison pill should be determined on a case-by-case basis, but generally should have the following attributes in order to gain a "FOR" recommendation:

§ a 20 percent or higher "trigger" for the acquisition of the target company's outstanding shares;

§ a two to three year sunset provision providing shareholders an opportunity to ratify or reject the rights plan at the end of the period;

§ no "dead-hand" or "no-hand" continuing director provisions, which provide that a rights plan can be redeemed only by continuing directors or cannot be redeemed after a change of control of the board, respectively;

§ a shareholder redemption feature pursuant to which holders of 10 percent or more of the shares may call a special shareholders meeting or seek written consents to vote on rescission of the rights plan if the board does not redeem the plan within 90 days after the announcement of an offer;

§ a "qualifying offer" or "chewable" feature [discussed below] [however, ISS recommends voting for plans containing the simpler shareholder redemption feature over chewable pills];5 and

§ ISS has also suggested that rights plans be subject to shareholder approval within one year of adoption.6

§ In addition, ISS recommends withholding votes for directors in uncontested elections who:

§ implement or renew a dead-hand poison pill;

§ ignore a precatory proposal approved by a majority of the votes cast for two consecutive years; or

§ ignore a precatory proposal approved by a majority of the shares outstanding.

C. TIAA-CREF.

§ TIAA-CREF's Policy Statement on Corporate Governance states that companies should "make a compelling case prior to adopting" a rights plan, that "any anti-takeover measure should have relatively short expiration periods of no longer than three years" and that it strongly opposes anti-takeover provisions that contain "continuing director" or "deferred redemption" provisions.7

D. CalPERS.

§ CalPERS Governance Guidelines state that no board should enact or amend a rights plan without shareholder approval.8
 
Corporate Response Options

In recent years companies have responded in a variety of ways to shareholder proposals concerning the adoption of rights plans. Table 1 summarizes company responses and other outcomes to rights plan proposals submitted in 2004. Some responses do not fall squarely within one particular category, and each company's circumstances are unique, but the table provides a helpful guide to how public companies have recently responded to these proposals.

The table indicates that a significant number of companies have elected not to respond to shareholder proposals at all. The table also indicates, however, that many companies have taken some action in response to such a proposal, ranging from complete acquiescence to the proposal to the adoption of one or more of the intermediate responses discussed below.

A. Take No Action. One alternative for a company is to take no action in response to a precatory proposal to require shareholder approval of any rights plan, regardless of the outcome of the vote on the proposal. As noted, many companies continue to do so, presumably because they believe that rights plans, if properly used, are in the best interests of shareholders. However, this approach is increasingly considered to be inconsistent with good corporate governance practices and is likely to subject the company to negative publicity and risks alienating additional shareholders.9

B. Agree to the Proposal. Alternatively, a board confronted with a precatory proposal requiring shareholder approval of rights plans could recommend that the shareholders vote in favor of the proposal. The principal advantages of this approach are that the company may gain some positive publicity, particularly from shareholder activist groups, and free market adherents on the board may favor this position.

The principal disadvantage of this approach, however, is that the vast majority of these proposals require shareholder approval prior to, or shareholder ratification following, the adoption of any rights plan. The ability of shareholders to preclude a board from adopting a rights plan or to require a board to redeem a previously adopted plan could be extremely disadvantageous to a board faced with a hostile offer.10

C. Implement Restrictions on the Adoption of Any Future Rights Plan. There are a number of intermediate steps that a company could take in response to the proposal that would allow its board to retain significant flexibility in implementing a rights plan in the future. Some of these intermediate steps are reviewed below.

1. Adopt only a "TIDE" plan. A board could agree that even though it will not subject the adoption of a rights plan to shareholder approval, it will agree to amend its current rights plan to include [and include in any future rights plan] a Three Year Independent Director Evaluation [TIDE] plan.

Under a TIDE plan, a committee of independent directors [or all independent directors as a group] is given the authority to review a rights plan [assuming one has been adopted] every three years [or some other specified period] and upon the occurrence of any event that could trigger the plan and the issuance of rights thereunder. The purpose of the review is to permit the independent directors to make a determination as to whether the plan continues to be in the best interests of the company's shareholders.

Under most TIDE plans, if the independent directors conclude that a rights plan is no longer in the best interests of a company's shareholders, they have the authority to rescind it.

To date, at least 76 companies have amended their rights plans to include TIDE provisions, some of which also include chewable features [discussed below].11 Other companies without rights plans have also agreed that if they adopt a rights plan in the future it will contain a TIDE provision.12

2. Adopt only a "chewable pill." A board could agree that even though it will not subject the adoption of a rights plan to shareholder approval, it will agree to only adopt a rights plan that has certain features that limit the ability or effectiveness of the plan to prevent unsolicited takeovers [a so called "chewable pill"]. Under a chewable pill, a rights plan will not be triggered and the rights will not be issued if an offer meets certain criteria [and thus is a "Qualifying Offer"], which may include one or more of the following:

§ The offer is structured to include a back-end merger at the same price as the offer price.

§ The offer is structured in such a way as to permit the target sufficient time to explore alternative transactions.

§ The person making the offer has adequate cash financing to pay for all the outstanding shares of the target on a fully diluted basis and all transaction and related expenses. [However, consider the limiting effect this may have on stock-for-stock transactions.]

§ The offer must remain open for a minimum period of time [e.g., 40 to 90 days] and must be extended for at least 20 days after any price adjustment or the receipt of a bona fide higher alternative offer.

§ The offer must be at a premium over the average closing price of the target's common stock on the principal stock exchange on which it is traded over a specified, pre-announcement trading period.

§ The offeror must obtain a fairness opinion to the effect that the offer is fair to the target's shareholders from a financial point of view.

§ The offer must not be conditioned on completion of the acquiror's due diligence investigation.

A chewable pill might also contain an unusually high stock accumulation or ownership threshold before the plan is triggered. Substantially all rights plans have a 15 or 20 percent stock accumulation threshold before the plan is triggered [ISS recommends at least 20 percent]. A chewable pill could have a 30 or 35 percent threshold.

3. No adoption until a non-qualifying offer is received. A board could also agree that it will not adopt any rights plan unless and until it receives an offer that is not a Qualifying Offer. This approach has the advantage of giving a board flexibility to implement a rights plan in the future depending on the kind of offer it receives, without committing itself in advance to any particular terms in the rights plan.

4. Adopt rights plan with an early redemption feature. As an alternative or in addition to the "Qualifying Offer" feature, a rights plan [in conjunction with a company's bylaws] could contain a shareholder redemption feature. This feature allows a specified percentage [e.g. 10 percent] of the shareholders to call a special meeting of shareholders or seek the written consent of all shareholders to rescind a rights plan within some specified time period [e.g., 90 days] after the announcement of an offer if the board does not redeem the rights plan. This approach is currently favored by ISS over chewable pills.13

5. The "Hewlett-Packard" approach. One approach, recently undertaken by the Hewlett-Packard Company, is to agree to subject the adoption of any future rights plan to shareholder approval unless the board, exercising its fiduciary duties under applicable state law, determines that doing so is not in the best interests of the shareholders under the circumstances [the HP Approach].

This approach provides a board with a great deal of discretion to adopt a rights plan without shareholder approval and does not provide shareholders with much control or influence over the adoption of a plan. For these reasons it may not be viewed as an adequate response to a precatory proposal. However, the SEC recently concluded that HP's policy was sufficient to constitute the substantial adoption of the precatory proposal submitted to Hewlett-Packard. Accordingly, if a company were to adopt this approach, the SEC may permit the company to exclude a precatory proposal from its proxy statement.14

6. The "Dow Chemical approach." Dow Chemical Company, in response to a precatory proposal that was subsequently withdrawn, adopted an approach that had three principal features:

§ The company agreed not to adopt any rights plan without shareholder approval, subject to the right to do so if the board determines in the exercise of its fiduciary duties that the adoption of a rights plan without such a vote is in the best interests of the company shareholders;

§ If any rights plan is adopted under the exception, the plan would be subject to a binding or non-binding shareholder vote or would expire by its terms within one year after its adoption; and/or

§ Any subsequent policy change with respect to rights plans would be subject to a binding or non-binding shareholder vote.

The Dow Chemical Approach has been used by several companies without rights plans in place, including JPMorgan Chase and Occidental Petroleum, and generally contains three principal features.15 In many instances the proponents withdrew their proposals after the subject company agreed to some variation of the Dow Chemical Approach outlined above.

Because most of the proposals were never submitted for shareholder approval, ISS's position on the Dow Chemical Approach is unclear. The Counsel of Institutional Investors considers the Dow Chemical Approach problematic because of the potentially lengthy delay until the next annual meeting in seeking shareholder ratification of a previously adopted rights plan.16

From the SEC's standpoint, since the Dow Chemical Approach goes further than the HP Approach, the agency should permit a company to exclude most precatory proposals regarding rights plans from its proxy statement if the company adopts the Dow Chemical Approach prior to the related annual meeting.

7. Recommended approach. The Dow Chemical Approach may unduly constrain a board because it requires that any future rights plan be subject to a subsequent shareholder vote within one year [even though that need not be a binding vote]. An alternative approach [the Recommended Approach] that strikes a middle ground between the HP Approach and the Dow Chemical Approach consists of the following primary elements:

§ Amend the company's rights plan to include a two-year TIDE provision;

§ Agree to submit the plan to a binding or non-binding shareholder vote at the second annual shareholders' meeting following the amendment of the plan as described above unless [i] the company is confronted with a hostile takeover bid at the time and [ii] the fiduciary exception described below is applicable; and

§ Agree that the company will not renew or extend its existing rights plan or adopt a new plan unless the independent directors determine that adoption of a plan is necessary or desirable to protect the best interests of the company's shareholders and/or is necessary or desirable to satisfy the board's fiduciary obligations under state law.

The approach outlined above is a meaningful response to a precatory proposal seeking to subject a rights plan to shareholder approval that ensures that the rights plan will remain in place as a deterrent to a hostile takeover. There is a good chance that many proponents of precatory proposals regarding rights plans would drop their proposals if a company were to follow the Recommended Approach. In addition, as with the Dow Chemical Approach, the SEC would likely permit a company to exclude such a precatory proposal from its proxy statement if the Recommended Approach were adopted by the board in a timely manner.

In response to a precatory proposal requiring shareholder approval of rights plans, a board should consider negotiating with both the proposal's proponents and the staff of the SEC.

A company that is the subject of a precatory proposal requiring shareholder approval of rights plans should consider seeking to reach a settlement with the proposal's proponents pursuant to which they would withdraw the proposal in exchange for adoption by the company of one or more of the intermediate approaches discussed above.

At the same time, a company that is the subject of such a precatory proposal should explore with the staff of the SEC the possibility that the company's adoption of the Recommended Approach or something similar to it would constitute substantial compliance with the proponent's proposal so as to permit the company to exclude the proposal from its proxy statement. If the SEC staff accepts this approach, the company could exclude the proposal even if it is unable to reach a settlement with the proponents of the proposal.

If the company cannot reach agreement with either the staff of the SEC or the proponents prior to the company's next annual shareholders meeting, the company should explore further whether the Recommended Approach would be acceptable to ISS and, if so, consider adopting that approach and submitting it to the shareholders for approval. If it is not acceptable to ISS, we recommend that the company consider adopting the Dow Chemical Approach.

Assuming a vote on a precatory proposal regarding rights plans goes forward and is approved by the company's shareholders, the company could respond to that vote by agreeing to implement one or more of the intermediate steps outlined above, including the Recommended Approach, the Dow Chemical Approach, a Hewlett-Packard-type plan or some other solution. The company could make this commitment in various ways, including by means of a press release, a bylaw provision, a charter amendment or a board resolution. Note that a commitment to implement a particular course of action in a press release, board resolution or bylaw amendment are reversible steps, i.e., the company could issue a subsequent release reversing the earlier-announced decision or it could amend the bylaws to eliminate the provision regarding the policy.

However, a commitment to submit a future change in policy to a shareholder vote [as is the case under the Recommended Approach] could be difficult to reverse as it would potentially raise serious credibility problems as well as issues under the federal securities laws. A charter amendment would require shareholder approval and would be very difficult to reverse.

1. 2003 and 2002 Georgeson Shareholder Services, "Annual Corporate Governance Review."

2. As of Sept. 21, 2004.

3. "Poison Pill Proxy Analysis and Company Response - All Proposals to Redeem or Require Shareholder Vote Results Summary and Trend Analysis, 2001-2004," published by SharkRepellent.

4. Council of Institutional Investors, "Corporate Governance Policies - Voting Requirements."

5. Institutional Shareholder Services, "Proxy Voting Manual, Poison Pills" [Shareholder Rights Plans] [hereinafter ISS Proxy Voting Manual].

6. Telephone conversation with Alan Miller of Innisfree M&A. Although ISS has not indicated whether a shareholder vote approving a rights plan should be binding or precatory, ISS would most likely require the former prior to recommending a "for" vote in favor of the policy or plan.

7. TIAA-CREF, "TIAA-CREF Policy Statement on Corporate Governance - Antitakeover Provisions", p. 14.

8. Beth M. Young, "Shareholder Proposals Regarding Takeover Defenses," The M&A Lawyer [March 2002] [5 No. 9 GLMALAW 13].

9. As noted above, ISS recommends withholding votes for directors who are not responsive to precatory shareholder proposals that have passed for two consecutive years by a majority of the votes cast, including proposals concerning rights plans.

10. For example, if a company bound by a precatory proposal requiring it to seek shareholder ratification of any rights plan at its next annual shareholders meeting were to become the subject of a hostile bid shortly before the meeting, the utility of any rights plan could be severely limited because the company's shareholders could repeal the plan at the meeting.

11. See, TrueCourse, Inc., "Poison Pills with TIDE Provisions."

12. For example, both General Motors Corporation and Hercules Incorporated have taken this approach.

13. ISS Proxy Voting Manual.

14. SEC No-Action Letter, Hewlett-Packard by Nick Rossi, publicly available Dec. 24, 2003 [2003 WL 23148894]. Specifically, the SEC stated in its response to the no-action request: "There appears to be some basis for your view that Hewlett-Packard may exclude the proposal under rule 14a-8[i][10]. We note Hewlett-Packard's representation that the board has adopted a resolution that requires a shareholder vote to adopt or extend any poison pills. Accordingly, we will not recommend enforcement action to the Commission if Hewlett-Packard omits the proposal from its proxy materials in reliance on rule 14a-8[i][10]."

15. See, Innisfree Memorandum re "Response to Shareholder Proposals by Companies without Poison Pills", dated Nov. 26, 2003. The approach varies somewhat from company to company in terms of whether the plan and/or the policy is ratified by shareholders.

 

16. Council of Institutional Investors February 2004 Newsleteer.

For example, Dow Chemical and JPMorgan Chase agreed to submit any rights plan they adopt to a non-binding shareholder vote within one year of adoption and Sabre Holdings agreed to submit any rights plan it adopts to shareholder approval at the annual meeting following adoption [without specifying whether approval would be binding]. Exxon Mobil and Occidental Petroleum specified that any rights plan they adopt must be "ratified" by the shareholders or expire within one year. With respect to changes in the rights plan policies, Dow Chemical and JPMorgan Chase agreed to submit any change in policy to a non-binding shareholder vote; Marathon Oil and Occidental Petroleum agreed to have their policies reviewed on an annual basis by their respective corporate governance committees; and Sabre Holdings and Exxon Mobil made no statement concerning review or repeal of their respective policies.

 

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