Einhorn v. Apple: Round One Technical for Einhorn
posted by Lawrence Cunningham
In corporate law, there are two broad strategies shareholders can adopt to challenge board action: a substantive claim that decisions breach fundamental fiduciary duties and a technical claim that decisions violate the machinery of corporate statutes, regulations, charters, bylaws or contracts. Shareholders often find that they lack strong substantive grounds and therefore pursue technical ones and vice versa. Such is the story of the shareholder David Einhorn’s campaign against the board of directors of Apple, Inc., a California corporation, round one of which went today to Einhorn on technical grounds.
The substantive fight is about how Apple should allocate substantial accumulated cash, running to some $140 billion. The board wishes to retain it; the shareholder wants it distributed to shareholders. Einhorn envisions using a specific approach to distributing the cash that would involve the issuance of a new class of preferred stock to existing shareholders with a stated cash dividend. Einhorn has no right to direct the board on such a matter and any claim challenging the board’s decision would be decisively dismissed. In fact, I cannot imagine any reputable attorney filing such a suit. Boards, not shareholders, set dividend policy.
So Einhorn’s lawyers turned technical, generating a high-visibility fight over arcane laws governing proxy statements such as Apple had recently circulated ahead of its upcoming annual meeting. One proposal indirectly addresses Einhorn’s idea of having the Apple board create a new class of preferred as a vehicle to make the distribution he seeks.
The proposal is to amend Apple’s charter to eliminate a provision giving the board the unilateral power to issue new classes of preferred stock on such terms as the board chooses. Absent such a clause, any such issuance would require a shareholder vote.
Apple’s board made this proposal for reasons that have nothing to do with Einhorn’s campaign. Such blank check preferred, as the vernacular calls it, has historically been seen as a strong pro-management device, not pro-shareholder, as it gives a board vast unilateral power ordinarily shared with shareholders. In fact, many Apple shareholders, including the large institutional investor and governance advocate, CalPERS, have long sought just such a proposal.
Again, Einhorn does not and cannot challenge the proposal in substance, because it is a perfectly legitimate proposal for a board to make and one that many shareholders have long championed. So Einhorn’s lawyers drilled to even deeper technical law. Federal securities regulations fashioned by the SEC say that when companies put proposals for shareholder votes they cannot bundle numerous different proposals together but must put each up for a vote. (SEC, Proxy Rule 14a-4.)
When Apple published its proxy statement earlier this year, it had decided to treat the amendment of its charter as a single topic, within which a few different proposals were indeed clustered. In addition to repealing the blank check preferred, the proposal requires majority voting for directors (another pro-shareholder reform proposal long-sought at many companies by institutional investors) and establishing a par value for the company’s stock of $0.00001 per share (a highly-technical change).
A federal judge today said Apple is not allowed, under the SEC rule, to bundle those charter amendment proposals into one, handing Einhorn a technical victory. Apple’s CEO calls the case a silly side show. Einhorn is boasting of victory. Who is right?
The technical procedural machinery of corporate governance often works in strange ways to give shareholders avenues of redress that substantive fiduciary duty law cannot handle. Statutes, regulations, charters, bylaws, and contracts set the rules and allocate power in ways that all must respect. Apple’s proposed charter amendment has nothing to do with the wisdom or prudence of what to do with all that $140 billion in cash. But Einhorn and the Apple board do have differing business judgments and both are allowed to use all that machinery to battle for the policy they favor.
In a way, Einhorn and Apple’s CEO are both right. Einhorn won this technical round but the substantive power about the dividend policy remains firmly in the board’s hands.
February 22, 2013 at 10:00 pm
Posted in: Corporate Law
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Responses (7)
Lawrence Cunningham - February 22, 2013 at 11:11 pm
My friend, the noted value investor Whitney Tilson, points out that Einhorn’s case for his proposed preferred stock, which he cutely calls iPrefs, is summarized by Einhorn’s slide presentation made yesterday, which can be found at: http://www.scribd.com/fullscreen/126634859?access_key=key-3cjmbd6nenfqls059uc. According to Whitney:
“I think iPrefs are a brilliant idea that uniquely works for Apple, given its enormous pile of cash (that exceeds the market capitalization of all but 17 companies in the S&P 500–incredible!), huge cash flows, yet depressed multiple. By creating a dedicated high-yield instrument in this yield-starved environment, iPrefs would unlock a lot more value than more traditional techniques like a special dividend and/or an increase in the dividend and/or share repurchase program.”
Shag from Brookline - February 23, 2013 at 7:27 am
I recall the days when corporate tax planning for highly profitable companies included the potential of the accumulated earnings tax. Is that tax dead on arrival for technology companies such as Apple?
Lawrence Cunningham - February 23, 2013 at 7:51 am
Shag: That tax continues but has limited application, as I understand it. It requires several things that don’t seem present in this case. The most basic seems to be that the purpose of accumulation is to enable shareholders to evade federal income tax. To probe that involves evaluating the reasonable needs of the business for such accumulation and Apple (like other tech companies and many huge companies) tells a story about cash needs. The third considers whether the corporation has a policy of shareholder distributions of any sort, and Apple has paid a regular dividend for many years and also engages in a share repurchase program. Turning back to corporate law, decisions about the tax implications are within the plenary power of a board of directors, not shareholders.
Shag from Brookline - February 23, 2013 at 8:27 am
I last studied in detail the AET Regs. back in the early 1980s. Back then, there was no special tax break for a shareholder receiving dividends comparable to the Bush tax cuts in 2001. Many hi-tech firms back then, and their shareholders, preferred increases in stock values over dividends, with the benefit of relatively low long term capital gain rates. As to the reasonable needs of the business, with the accelerating advances in technology in more recent years, plans for such can be quite subjective, making it difficult for the IRS to challenge such plans (especially with inadequate funding of IRS by Congress over the years). I accept the role of the Board of Directors regarding dividends. Considering the significant cash hoards of Apple and others, perhaps tax reform might consider giving the AET more of a bite, not only of Apple, but other firms with large cash hoards. Query: If an AET were imposed, might a Board of Directors have liability concerns under corporate law?
[I wonder if in Apple's SEC filings references are included on its plans for its cash hoard to gauge whether such plans are "reasonable" or referencing any risk of a potential for the AET.]
Shag from Brookline - February 23, 2013 at 8:55 am
I did a little Googling and came up with the Ethics- Legal Lady Blog at:
http://ethics-legallady.blogspot.com/2012/09/ethics-of-accumulated-earnings-tax.html
with its 9/9/12 post “Ethics of Accumulated Earnings tax
that includes a discussion of Apple and other hi-tech companies and the AET.
Jennifer Taub - February 23, 2013 at 9:01 am
Larry,
Thank you for writing about this. I will link to this on TWEN for my corporations classes.
In corporations, in addition to using your textbook, students are assigned to follow one of ten corporations, one of which is AAPL.
As part of that, students reviewed financial statements early in the semester, and just this week, proxy voting. For most teams, this meant the 2012 proxy and the post-meeting 8K showing voting results. However, for AAPL, given the early annual meeting, there was an opportunity to look at 2013.
The AAPL team (and broader class) is interested in Einhorn and the preferred stock issue.
This post is quite helpful now and will also be useful when we cover fiduciary duties.
Lawrence Cunningham - February 23, 2013 at 4:11 pm
Another friend suggested that I include a link to the comments of Apple’s CEO, Tim Cook, about this whole matter from a couple of weeks ago. The link is here:
http://www.macworld.com/article/2027900/this-is-tim-cook-at-the-2013-goldman-sachs-conference.html
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