Corporate Governance Archives - That's Not Market

Do Startups and Other Private Companies Have to Provide Info to Employees?

If the employee is a stockholder, private companies, including secretive tech startups and other private emerging growth companies, must provide some company information, as confirmed by old law and new case.

Some ink is being spilled regarding the Biederman v. Domo case about a former employee and current stockholder suing Domo for financial information. Some of the ink tells the story, but some get it wrong. Let’s take a look.

I’m using news reports since I could not find an opinion or ruling, so accuracy may vary as we will see.

Domo usually keeps its financial information secret, like most companies. Domo also pays its employees in stock and options, like many tech and startup companies. Domo was richly valued in VC rounds, like many tech and startup companies. Domo’s value may have declined, like many tech and startup companies that were richly valued in VC rounds.

Biederman wanted information about Domo’s financial condition, Domo wanted a confidentiality agreement. Biederman refused. According to the Information, this

“highlighted an obscure Delaware law that gives investors the right to financial information of private tech firms in which they hold stock.”

The San Francisco Business Times (the “SFBT“) misreports the Information by stating that

“The Information reports that a Delaware law applies to any privately held company that has issued more than $5 million in stock awards in a year and is incorporated in the state. The rule allows employees of any U.S. private company a right to detailed financial information — even if they work for the famously opaque and sometimes secretive tech sector.”

Let’s unpack this a bit.

First, Section 220 of the Delaware General Corporation Law is not obscure. It is commonly invoked by stockholders who demand information. The universe of documents available to the stockholder is limited and related to the stockholder’s purpose for requesting the information.

Second, with respect to the SFBT, Delaware law cannot apply “to any privately held company,” only those subject to Delaware’s jurisdiction. The $5 million figure refers to SEC Rule 701, which exempts certain compensation benefit plans from SEC registration requirements and has nothing to do with Delaware law. Basically, certain disclosure requirements are triggered if the value of equity awards in a 12-month period exceeds $5 million.

None of this is new. There are those, particularly in the tech world, who don’t understand that old rules apply to them. You can’t force a stockholder to sign an agreement as a condition to exercising statutory rights. I suppose you can try, but a court may disagree. In some states, a company may be subject to penalties for refusing access to books and records.

Generally speaking, private companies do not have to make disclosures to stockholders (employee or otherwise). However, there are circumstances where statutes and regs require opening up, such as:

pursuant to a proper books and records inspection request (most states have statutes requiring this, and the request has to be in proper form);
while there are usually no specific disclosure requirements for stockholder meetings, fiduciary considerations apply when asking for stockholder vote, such as M&A transactions; and
state and federal antifraud and registration/exemption rules apply when securities are involved.

Probably a different Domo, but Domo wants his stockholder books and records information. — Probably a different Domo, but Domo wants his Biederman stockholder books and records information.

Shopify Shows How Silicon Valley Corporate Governance Structures Spread and Become the Norm

Shopify IPO documents outline corporate governance strategies with concentrating voting for insiders.

Shopify filed for an IPO. It is raising around $100 million (a placeholder figure), but it is too early to know exactly how much of the company this represents.

Shopify IPO reveals dual class voting structure.

We do know that Shopify is implementing a dual share voting structure similar to many other tech companies. While corporate governance activist types decry these types of arrangements, even a Canadian company knows how to protect the voting rights of its insiders. Proponents say these structures allow for longer term thinking and innovation.

Currently, officers and directors control about 56.5% of the voting rights, with CEO Tobias Lutke holding 14.62%. The 56.5% number is skewed because this includes investor nominees to the board, including Bessemer Venture Partners (30.3%).

The voting rights will be split up between Class B shares with 10 votes per share and the publicly held Class A shares with 1 vote per share. The prospectus outlines the risk of concentrated voting. However, it is not really a risk. It is the point.

“In addition, because of the 10-to-1 voting ratio between our Class B multiple voting shares and Class A subordinate voting shares, the holders of our Class B multiple voting shares, collectively, will continue to control a majority of the combined voting power of our voting shares even where the Class B multiple voting shares represent a substantially reduced percentage of our total outstanding shares. The concentrated voting control of holders of our Class B multiple voting shares will limit the ability of our Class A subordinate voting shareholders to influence corporate matters for the foreseeable future.”

A Brief Reaction to a Small Part of “Assessing Silicon Valley Corporate Governance Measures” Article

The Recorder recently ran an article discussing Fenwick & West’s corporate governance study. I believe F&W produces these annually, and they are excellent resources for anyone interested in the up-to-date information about corporate governance practices, particularly for Silicon Valley companies.

However, there was an interesting statement at the beginning of the article:

“When companies are seeking to establish appropriate corporate governance policies, they often look to model themselves after those titans of industry in the Standard & Poor’s 100.”

Well . . . sometimes.

More often, companies will look to the companies that:

they deem somewhat comparable to the themselves; and
they aspire to be.

Typically, that will include prominent companies in their industry, which may or may not include companies in the S&P 100, 500, Pick-A-Number. They also account for size and complexity and other factors.

For many companies, the governance practices of the S&P 100 will be far too complex and have far too many processes and procedures to have any value. There will often be fewer people in the decision-making process, fewer layers of bureaucracy and the fewer issue-specific policies for smaller companies.

That said, the F&W studies tend to be extremely valuable, and I plan to spend a good part of the weekend reading the new one. I hope your weekend is better than that.

Can Open Market Stock Purchases Resulting In Majority Control Constitute A Breach Of Fiduciary Duty?

How about the board’s granting of the right to engage in those purchases?

Answer: No.

Link: In re Sirius XM Shareholder Litigation

Background

In 2009, Sirius was hurting. Liberty Media was nice enough to provide $530 million for a 40% interest, some board seats and some consent rights. The agreement included a standstill provision preventing Liberty from gaining majority control for three years. Following the standstill period, the agreement prevented Sirius from using a poison pill or charter or bylaw amendment to interfere with additional purchases of Sirius stock by Liberty. The investment and agreement were disclosed publicly.

At the end of the standstill period, Liberty announced it would obtain a controlling position through open market purchases. Sirius opposed it, and even opposed the FCC approval that Liberty would need in order to obtain majority control. However, Liberty was able to get its majority stake.

Plaintiffs sued claiming breach of fiduciary duty on the part of Liberty and the Sirius board of directors.

Fiduciary Duty Claims Against Sirius Board

The court initially noted that the time period for fiduciary duty claims ran from the time of the agreement in 2009, and thus their claims were time barred. The plaintiffs also argued that the board should have instituted a poison pill to prevent Liberty’s additional purchases, the court said this was not the wrongful act. The plaintiff’s complaints arise out of the initial agreement in 2009, and the plaintiffs did not have a good reason for waiting to file a lawsuit. The terms of the deal were fully disclosed in 2009, and the board’s inability to stop Liberty’s purchases were based on the 2009 deal.

Anything the board did that is subject of the plaintiffs’ complaint was based upon 2009 activity and, therefore, the statute of limitations ran from 2009. As the court said, “[u]nder Delaware law, a plaintiff’s cause of action accrues at the moment of the wrongful act – not when the harmful effects of the act are felt – even if the plaintiff is unaware of the wrong.”

Fiduciary Duty Claims Against Liberty

The Plaintiffs also argued that Liberty had a fiduciary duty even if it was a non-controlling shareholder when it initially invested in 2009. This duty of fairness would preclude Liberty from buying additional shares in the open market unless the Sirius board approved the terms.

The court disposed of this claim as well. First, they are time-barred because they were still the product of the arms-length negotiations and deal in 2009 when Liberty was not even a stockholder, much less a controlling stockholder. Second, open market purchases after disclosing the intent to make such purchases do not involve any control over Sirius’ board or misuse of Sirius’ resources by Liberty. There was no allegation of insider trading or an attempt to effect a going private transaction. To the contrary, even the plaintiffs conceded that Liberty’s purchase announcement would result in the market price for the Sirius shares to increase prior to purchase. As a result, what the plaintiffs are really claiming is a repackaging of their opposition to the 2009 deal.

The only real complaint of the plaintiffs is that the board did not institute a poison pill, which was not only prohibited by contract but is not actionable under Delaware law without additional bad acts (recall the Landry’s case, Louisiana Municipal Police Employees’ Retirement System v. Fertitta, 2009 WL 2263406 (Del Ch. July 28, 2009)).

The court finished with its adherence to basic corporation law and contracts:

“There are many situations when corporations enter into contractual arrangements that have important implications for corporate control in conceivable future situations; for example, debt instruments commonly give creditors rights that, if used, may result in their assuming control. The use of such rights to obtain control in the situations specifically contemplated by those contracts does not constitute a fiduciary breach. As this court has explained, even “[a] controlling shareholder is not required to give up legal rights that it clearly possesses; this is certainly so when those legal rights arise in a non-stockholder capacity.””

Where I Add to the Pile of Opinion Regarding Corporations vs. LLCs for Startups

I got another (non-client) question about whether I prefer corporations or LLCs for startups.

Short Answer:

It depends.

Long-Winded Answer:

I have found that an LLC will often provide more flexibility in terms of division of rights and responsibilities from the default rules in many business entity statutes. In addition, there is more flexibility in terms of pass-through tax treatment with an LLC than with a corporation, even with a Subchapter S election.

If there are a small number of owners, or it is owned by a single person, they can usually get to the same result regardless of the entity type. In that case, the most important thing is to have some type of limited liability entity in place, and a corporation and an LLC are similar enough that the same results can be achieved through a variety of strategies.

Many people suggest a corporation because it is easier to attract investors, but that is not necessarily the case. Only a small portion of small businesses attract the type of institutional investors (such as venture capital firms) that would require the company be organized as a corporation. Investors in some industries may expect specific organizational forms for their investment. For example, real estate or natural resources investors may expect the company to use a limited partnership.

If an entrepreneur is in discussions with, or knows it may want to approach, an investor prior to organization, the investor’s concerns can be met up front. However, in the beginning the organizational form should be driven by the entrepreneur’s and business’ needs. Unless the entrepreneur knows who will make the investment and what their criteria is, there is no way to predict the terms up front as every situation is different, and there is likely to be some required restructuring done prior to the investment in any case.

A Simple Question: What Does “Annual” in “Annual Meeting” Mean?

According to the Massachusetts Supreme Court, the answer isn’t quite so simple.

Link: Brigade Leveraged Capital Stuctures Fund, Ltd. v. PIMCO Income Strategy Fund

“Annual” means “annual,” right? How hard could it be. Let’s allow some ambiguous drafting, course of dealing and New York Stock Exchange regulations make it complicated.

Background

PIMCO is a big fund company and Brigade is an investor in two of its funds, each of which is a Massachusetts business trust.

The funds sent notices to investors of their intent to hold annual meetings as usual. Brigade sent notice that it was going to nominate a trustee for election at the annual meetings. PIMCO rescheduled the meetings to the last day of its fiscal year.

The funds’ declarations of trust require annual meetings at least 15 months after the first sale of shares and thereafter as specified in the bylaws.

The funds’ bylaws provide that annual meetings shall be held, so long as common shares are listed for trading on the NYSE, on at least an annual basis.

The NYSE requires listed companies to hold an annual shareholders’ meeting during the fiscal year.

Brigade filed suit seeking an injunction requiring PIMCO to hold the annual meeting as soon as practical and a declaration that the bylaws require an annual meeting at least once within any twelve month period.

Brigade contends that the rescheduling to nineteen months after the last annual meeting does not count as “annual,” which means within twelve months of the last annual meeting. PIMCO says “annual” means “during the fiscal year.”

What the Court Says “Annual” Means

Interpretation of Governing Documents

The court noted that the reference to the NYSE clearly means that an annual meeting must be held, at the very least, once every fiscal year, even though the bylaws do not explicitly say that.

However, the court reviewed the bylaw provision for shareholder notices together with the annual meeting requirement.¹ It also noted that the bylaws provided for a special meeting in lieu of annual meeting, which may take place outside of the “annual period,” a thirty day window following the anniversary of the previous year’s annual meeting, which is not an “annual meeting,” but a “special meeting.”

The court also noted that this interpretation is consistent with how PIMCO historically scheduled its meetings and the usual meaning of “on an annual basis.”

There is more going on here than contract interpretation, and you may already know this if you have ever dealt with this issue before a court.

The Real Issue

Many courts don’t come out and say it, but the Brigade court did. Where the bylaws are ambiguous, it will construe them against the drafters, in other words, the company.

The upshot is that courts do not like it when companies try to escape the wrath of a shareholder vote. As the court said,

“Moreover, where “bylaw provision are unclear, we resolve any doubt in favor of stockholders’ electoral rights.””

The court went on to quote a variety of shareholder friendly cases for the proposition that voting in corporate elections is a fundamental right of shareholders, and the court will not interpret ambiguous governing documents to allow the company to postpone an election.

________
¹Bylaws Section 10(c):

“To be timely, the Shareholder Notice must be delivered to or mailed and received at the principal executive offices of the Trust not less than forty- five (45) nor more than sixty (60) days prior to the first anniversary date of the date on which the Trust first mailed its proxy materials for the prior year’s annual meeting; … provided, … however, if and only if the annual meeting is not scheduled to be held within a period that commences thirty (30) days before the first anniversary date of the annual meeting for the preceding year and ends thirty (30) days after such anniversary date (an annual meeting date outside such period being referred to herein as an “Other Annual Meeting Date”), such Shareholder Notice must be given in the manner provided herein by the later of the close of business on (i) the date forty-five (45) days prior to such Other Annual Meeting Date or (ii) the tenth (10th) business day following the date such Other Annual Meeting Date is first publicly announced or disclosed” (emphasis added).

Outsourcing Corporate Boards?

An interesting proposal by a couple of corporate law professors may cause you to rethink how companies populate their boards.

Law professors M. Todd Henderson (U. Chicago) and Stephen M. Bainbridge (UCLA) have proposed a novel way to expand further the universe of corporate service providers by allowing the outsourcing of board functions.

The profs note that critics complain that the array of tasks for a board to deal with are too vast for a board to perform effectively. They also note that “boards fail to police managers adequately or make good decisions” and that they are generalists without the breadth of experts the company may need.

First, boards generally, and exchange listed board committees specifically, have the ability to hire expert advisors directly without relying on company management.

However, this brings up a point that has bothered me for a while. Before, and particularly after, Sarbanes-Oxley, the corporate governance “experts” have emphasized the need for independent board members, free of the influence of management. However, with respect to the operations and performance of a company, that responsibility and information resides with management.

In other words, particularly in the post-Sarbanes-Oxley world, the most sensitive and important decisions are under the purview of the people with the least connection to the company and the least access to the information. I understand the fear of conflicts of interest and the desire for input free of the influence of management, but this seemed to me to be a mismatched solution.

Basically, I’m not sure I agree with the critics. You can point to specific governance horror stories, but there are thousands of public companies and many thousands more private companies where corporate boards operate adequately or even successfully. There are actual instances of effective governance that pre-date Sarbanes-Oxley, if you can believe it. In the case of policing management and making crucial policy decisions, why would you have those responsibilities rest with the individuals furthest removed from the company?

In addition, there are many examples of corporate boards with structures resembling the All Governance Expert Blue Ribbon Panel Paradigm that turned out to be miserable governance failures (*cough*Enron*cough*).

I know this was a bit of tangent, but it was my first reaction to the profs’ article. There will be more. It is recommended reading.