During February and March of 2010, the USPX intervened in a lawsuit that, if lost, could have devastated shareowner rights. The event provides a cautionary tale of how distorted the concept of share ownership has become, and the lengths some CEOs will go to suppress shareowner rights.
It all started in January, when shareowner activist John Chevedden, who files many shareowner proposals and is a celebrated champion of shareowner rights, was sued by Apache Corp. Chevedden had submitted a proposal for inclusion in Apache’s 2010 proxy materials. The suit was ostensibly to challenge the evidence Chevedden had provided documenting his ownership of Apache shares, but it was perceived by parties on both sides as a SLAPP (strategic lawsuit against public participation) suit intended to punish Chevedden for his shareowner activism. One mean-spirited subscriber to http://thecorporatecounsel.net anonymously commented:
I am glad they are taking Chevedden to court … If he started getting his butt hauled into court all across the country, then his proposals would cost more than the price of a stamp.
But the lawsuit had implications far beyond squeezing one shareowner activist. Shortly after the lawsuit was filed, it came to light that Apache CEO Steve Farris had suggested to the SEC in 2007 that non-binding shareowner proposals be banned outright. An adverse ruling in Apache vs. Chevedden would have largely accomplished that. Here’s why:
In the lawsuit, Apache’s lawyers seized on poorly written SEC Rule 14a-8, which specifies how to document share ownership for the purpose of submitting a proposal. Today, the vast majority of shares are held in street name, which means the beneficial owner’s name doesn’t appear on a corporation’s stock ledger. Rule 14a-8(b)(2) says that a beneficial shareowner can prove ownership by submitting
… to the company a written statement from the ‘record’ holder of your securities (usually a broker or bank) verifying that, at the time you submitted your proposal, you continuously held the securities for at least one year.
Shareowners and corporations had long understood, and the SEC had confirmed on a number of occasions, that this means a letter from a shareowner’s bank or broker is sufficient. Chevedden had provided such a letter from his bank, Ram Trust. However, Apache’s lawyers interpreted the rule as saying something entirely different.
In the 1970s, most stock certificates in the United States were immobilized in a central depository called Depository Trust Corporation (DTC). Technically, DTC (which also goes by the name Cede & Co.) is the owner of record for most US stocks. DTC holds shares on behalf of large custodial banks, who typically own them on behalf of other institutions. In this way, shares are held through “daisy chains” of security entitlements linking beneficial owners through multiple financial institutions to DTC. But DTC only knows about the custodial banks. It has no information about other institutions or individuals further down a daisy chain.
Since DTC would be the only entity on a daisy chain to actually appear on a corporation’s stock ledger, Apache’s lawyers claimed Chevedden, and presumably any other shareowner submitting a proposal, would need a letter from DTC to confirm share ownership. If the judge ruled in Apache’s favor, this would create an impossible precedent for shareowners. They would need to get a letter from DTC in order to submit a shareowner proposal, but DTC could not possibly provide letters confirming matters of which they had no knowledge.
Disputes such as this are generally decided through a no-action procedure established by the SEC to conveniently and inexpensively resolve issues. Through that process, a corporation that wants to exclude a shareowner proposal from its proxy materials may request a no-action letter from the SEC confirming the SEC would be unlikely to take regulatory action. The process is informal, and parties always have recourse to the courts. But it is inexpensive and convenient. Disputes between corporations and proponents of shareowner proposals almost never go beyond the no-action process.
In 2007, another corporation, Hain Celestial, had made the exact same argument about Rule 14a-8(b)(2) that Apache was now making. They had made it in a no-action request, which the SEC had denied. Had Apache made a similar no-action request, they would certainly have been denied. Instead, they went directly to US District Court in Houston, requesting a ruling that they be allowed to exclude Chevedden’s proposal. They also asked that the court force Chevedden to pay their legal expenses.
Apache hired an expensive Houston law firm. With Apache’s shareowners footing the bill, they quickly filed multiple motions with the court followed by a extensive legal brief. Lawyers we consulted estimate defending the case would cost $50,000 to $100,000.
John Chevedden heroically stood up to Apache and its lawyers. Lacking funds to hire lawyers, he chose to represent himself pro se. All shareowners owe him their gratitude, not only for his efforts in this case, but for his tireless work on their behalf over many years of submitting shareowner proposals. However, pro se litigants are rarely successful. With John Chevedden representing himself against high-priced Houston lawyers, the potential for an adverse ruling was significant. Shareowners’ right to submit proposals hung in the balance.
In February, the USPX intervened, petitioning the court for permission to file an amicus curiae (friend of the court) brief. Permission was granted. The USPX’s brief was a tour de force, exploring all aspects of the at-issue SEC rule—its history, practical implications, accepted interpretation and treatment in recent SEC staff legal bulletins and no-action letters.
The shareowner community was on edge. Suddenly it seemed possible and even likely that Chevedden might prevail. The clock was ticking. Apache had to send their proxy materials to be printed soon, but they couldn’t do so until the court decided whether they could exclude Chevedden’s proposal.
Apache’s lawyers scrambled over the weekend to meet a Monday deadline to submit a reply brief. That was supposed to be a minor follow-up to their original Brief on the Merits.
But the USPX amicus curiae brief changed everything, setting Apache’s lawyers back on their heals. The reply brief they filed that Monday was a rambling “hail Mary pass” of a brief. It tried to make an issue out of anything and everything while failing entirely to address substantive flaws in their case that the USPX had documented. Inauspiciously, Apache’s reply brief opened with an attack on the USPX itself.
Chevedden filed a Motion for Summary Judgment, which cut through many of the distractions and minutia of the Apache reply brief and asked the court to immediately rule on the material issues raised in the case.
The next day, the judge issued a ruling. Shareowners were glum when it first arrived, as it opened by declaring a “narrow” decision in Apache’s favor, but as they read on, shareowners realized just how “narrow” that decision was. On page after page of the decision, the judge rejected Apache’s evidence, its arguments, and ultimately its claim that (essentially) proponents of shareowner resolutions must document their holdings with a letter from DTC. Because it is impossible for DTC to provide such a letter, a ruling on the issue in Apache’s favor would have crippled shareowners’ ability to submit proposals. The judge’s rejection of Apache’s position transformed the lawsuit from a possible weapon of mass destruction against shareowner rights into a minor dispute over whether or not Apache may exclude John Chevedden’s proposal from its proxy materials for just one year. At the very end of the decision, the judge decided that minor issue in Apache’s favor. She did so on a technicality. That was the “narrow” decision.
The case was a mixed decision, but shareowners won. Apache had tried to squeeze Chevedden financially, but the suit cost him only postage for mailing a few documents to the court. Apache’s sweeping claims, which would have devastated shareowner rights, were rejected. Apache ended up with a consolation prize. Reflecting on the mixed outcome, Chevedden was reminded of the classic 1968 Harvard Crimson headline: “Harvard Beats Yale 29-29″.
Apache pressed the court to have Chevedden pay their legal expenses, but the court declined to do so.
One important detail remained unresolved: Would Apache or other corporations be able to exploit the judge’s narrow decision to block Chevedden or other shareowners from submitting future proposals? In just a matter of weeks, Union Pacific filed a no-action request with the SEC, seeking to exclude a Chevedden proposal on the grounds that the Apache vs. Chevedden decision applied. The USPX helped Chevedden draft a reply. It is worth quoting at length because it explains the flawed technicality on which the judge based her narrow decision:
Based on the United States Proxy Exchange amicus curiae brief, the judge rejected Apache’s position, but she found an excuse to rule that Apache could exclude the shareholder proposal for 2010. It is this same flawed ruling that Union Pacific is attempting to piggyback on for the purpose of, just as Apache did through the SLAPP suit, disenfranchise their own shareowners. There are two key caveats in attempting to rely on the Apache ruling in regard to other no action requests:
1. The judge described her ruling as “narrow,” stating explicitly
The ruling is narrow. This court does not rule 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.
2. The judge based her decision on material information provided by Apache’s lawyers that was factually incorrect.
The case was conducted on an accelerated schedule that bypassed oral arguments. Because it involved technical matters related to securities settlement and custody, the Judge was particularly dependent on the technical briefs submitted in the case. The fact that Apache’s lawyers made a number of claims that were blatantly false (as pointed out in the USPX brief) that may be why she made a “narrow” ruling that would only apply to situations with identical circumstances.
The Union Pacific no-action request does not entail identical circumstances to the Apache lawsuit, for a variety of reasons. One obvious reason is the fact that Apache Corp. provided the proponent with two detailed deficiency notices that explicitly challenged evidence of share ownership. Union Pacific provided just one cookie-cutter deficiency notice.
Once the USPX amicus curiae brief shot down Apache’s central arguments, Apache lawyers adopted an “everything but the kitchen sink” tack in a response brief. They cited any and every little fact they could come up with, vaguely implying … who knows what?
Based on the abbreviated timeline set by the judge, I was not to be allowed to respond to this “kitchen sink” brief. I submitted a motion for summary judgment, which afforded an opportunity to briefly respond to some of the Apache lawyers’ misrepresentations. But one slipped through. It is what the judge based her decision on, and it was totally incorrect. Here is what it was.
I hold my Apache and Union Pacific shares through Ram Trust Service (RTS). Apache’s lawyers visited the RTS website and noticed that RTS has a wholly owned broker subsidiary, Atlantic Financial Services (AFS). Apache then hypothesized that, perhaps, I actually held my shares through the broker subsidiary and not RTS. Apache then proposed undefined and the judge accepted that undefined the letter evidencing my share ownership should, perhaps, have come from AFS and not RTS. Here is what the judge said:
RTS is not a participant in the DTC. It is not registered as a broker with the SEC. or the self-regulating industry, organizations FINRA and SIPC. Apache argues that RTS is not a broker but an investment adviser, citing its registration as such under Maine law, representations on RAM’s website, and federal regulations barring an investment adviser from serving as a broker or custodian except in limited circumstances … The record suggests that Atlantic Financial Services of Maine. Inc., a subsidiary of RTS that is also not a DTC participant, may be the relevant broker rather than RTS. Atlantic Financial Services did not submit a letter confirming Chevedden’s stock ownership. RTS did not even mention Atlantic Financial Services in any of its letters to Apache.
After the judge’s ruling, I was able to follow-up with RTS. RTS confirmed that they are a Maine chartered non-depository trust company, and that they do in fact directly hold my shares in an account (under the name Ram Trust Services) with Northern Trust. Their letter made no mention of AFS because AFS plays no role in the custody of my shares. For purposes of Rule 14a-8, RTS is the record holder of my securities. The judge ruled “narrowly” against me because she thought AFS might be the real record holder.
Because the judge explicitly made her decision “narrow,” I believe it is irrelevant in this no-action request. Because the decision was based on material, factually incorrect information, it should not apply to this no-action request.
The SEC ruled in Chevedden’s favor, denying Union Pacific’s no-action request.
Two more corporations filed no-action requests to piggyback off the Apache vs. Chevedden decision: Devon Energy and News Corp. In both cases, the USPX helped the shareowner proponent draft a response for the SEC. In both cases, the SEC decided in favor of the shareowner proponent.