Einhorn v. Apple: Round One Technical for Einhorn
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.