Thursday, March 11, 2010

Half a Loaf? Narrow Court Opinion Allows Exclusion of Activist's Proxy Proposal

By James Hamilton, J.D., LL.M.

Apache Corp., a Texas-based energy company, may exclude a shareholder proposal submitted by John Chevedden from its proxy materials, according to a federal district court (SD Tex). In a rather unusual action, Apache sought a declaratory judgment that Chevedden failed to establish his eligibility to submit a proxy proposal. In a narrowly-drawn opinion, Judge Lee H. Rosenthal granted Apache's request. She wrote that Rule 14a-8 "does not necessitate a complete surrender of a corporation’s rights during proxy season. Rule 14a-8 requires a shareholder seeking to participate to register as a shareholder or prove that he owns a sufficient amount of stock for a sufficient period to be eligible. Although this court concludes that Rule 14a-8(b)(2) is not as restrictive as Apache contends, on the present record, Chevedden has failed to meet the Rule’s requirements." Apache Corp. v. Chevedden, Docket No. 4:10-cv-00076.

John Chevedden is well known to corporate governance practitioners and professionals. In one database search, the name of Mr. Chevedden, an activist shareholder, shows up in more than 150 no-action letters and requests in the last 12 months. In a series of no-action 2009 letter requests, several issuers wrote that "Mr. Chevedden and his tactics are well known in the stockholder proposal community." The issuers asserted that "although he apparently personally owns stock in a few corporations, through a group of nominal proponents Mr. Chevedden submitted more than 125 stockholder proposals to more than 85 corporations in 2008 alone. In thus circumventing the ownership requirement in Rule 14a-8(b), Mr. Chevedden has a singular distinction; we are unaware of any other proponent who operates in such a manner, or on so widespread a basis, in disregarding the Commission's stockholder proposal rules." In those letters, the SEC advised that the various proposals could not be excluded.

Rather than seeking staff permission to leave out his proposal, Apache Corp. notified the SEC that it intended to exclude the measure, and then sued Mr. Chevedden in federal district court. As alleged, Mr. Chevedden was not eligible to submit proposals because neither he, his introducing broker or the securities' custodian was a record holder of Apache stock. The company sought a declaratory judgment declaration that it could exclude the proposal in accordance with Rule 14a-8(b) and (f). Perhaps more significantly, Apache also sought to recover its attorney fees and expenses in connection with the action.

A key issue in the case was presented by a 2008 no-action letter to Hain Celestial Group Inc. concerning another Chevedden proposal on similar facts. The staff concluded that "we are now of the view that a written statement from an introducing broker-dealer constitutes a written statement from the `record' holder of securities, as that term is used in Rule 14a-8(b)(2)(i). For purposes of the preceding sentence, an introducing broker-dealer is a broker-dealer that is not itself a participant of a registered clearing agency but clears its customers' trades through and establishes accounts on behalf of its customers at a broker-dealer that is a participant of a registered clearing agency and that carries such accounts on a fully disclosed basis. Because of its relationship with the clearing and carrying broker-dealer through which it effects transactions and establishes accounts for its customers, the introducing broker-dealer is able to verify its customers' beneficial ownership."

Apache urged the court to disregard this staff interpretation, referring to it as a "rogue" letter. The court rejected Apache's view of the Hain Celestial letter. Judge Rosenthal wrote that the staff position in Hain Celestial was more consistent with the text of Rule 14a-8(b)(2) than the restrictive position Apache advanced, that the rule required confirming letters from the Depository Trust Company or Cede & Co. The court also rejected Apache's claims that the staff had retreated from its Hain Celestial position.

The case turned on the narrow issue of whether the one timely letter from Ram Trust Services, or RTS, which Chevedden asserted was his “introducing broker," was sufficient. The court concluded that "the inconsistency between the publicly available information about RTS and the statement in the letter that RTS is a `broker' underscores the inadequacy of the RTS letter, standing alone, to show Chevedden’s eligibility under Rule 14a-8(b)(2)." Judge Rosenthal stated that Chevedden’s interpretation of the rule would require companies to accept any letter purporting to come from an introducing broker, that names a DTC participating member with a position in the company, regardless of whether the broker was registered or if there were valid reasons to believe the letter was unreliable as evidence of the shareholder’s eligibility.

The court emphasized that it was not ruling on what Chevedden had to submit to comply with Rule 14a-8(b)(2). "The only ruling is that what Chevedden did submit within the deadline set under that rule did not meet its requirements," concluded the court. The judge also did not award legal fees to Apache.

Following such a narrowly-drawn opinion in the Texas case, and the lack of any fee award, it is not likely that large numbers of issuers will follow Apache's lead. Litigation is costly and time-consuming, and many issuers may be hesitant to square off against their own investors on questions that are procedural and not related to the substance of the proposal.

Apache Corp. has also staked out a somewhat unique position with its outspoken opposition to investor proxy access. In comments on the 2007 proxy access proposal (Release No. 34-56161), the company's CEO, G. Steven Farris, argued that allowing shareholders access to company proxies places domestic oil companies in a competitively disadvantageous position as compared to their foreign counterparts. He has also criticized the role played by proxy consultants in the process. He asserted that "non-binding proposals should not be permitted at all. They have no legal standing under the corporate laws of Delaware and other states, are an inefficient and ineffective method of communication between shareholders and companies, and distract attention from the genuine business issues presented for shareholder votes at shareholder meetings." He urged the SEC to "eliminate the federally created right of shareholders to make non-binding proposals."