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Di Alessandro Macrì – Cornell University
18 febbraio 2002
Before discussing U.S. corporate law, it is necessary to explain that this branch of law is not regulated by federal legislation, and therefore it is not homogeneous throughout the U.S. This premise is necessary to make it clear that this short article refers to U.S. corporate law in general and does not address any of the 50 states in particular since each of them states has passed its own code to set the rules for incorporated business organizations.
It is essential to understand that no matter where a corporation operates, its internal affairs are governed by the law of the state of incorporation, and that state has the sole jurisdiction on the issues of corporate governance. For example, a corporation chartered in Pennsylvania, but which conducts business in Washington, will be subject to Pennsylvania law for (1) vote on merger deals (2) on sale of assets, and (3) election of the board of directors. On the other hand, questions relating to contracts with suppliers located in Washington or to employment law are regulated by Washington law. As a matter of fact, most states modeled their bills on the Revised Model Business Corporations Act that was prepared by a committee of the American Bar Association and that with the Model Business Corporations Act largely influenced the corporations statutes of over half of the states.
Some states are “permissive” and give organizers and shareholders wide discretion to establish their rules of corporate governance. The most permissive state is Delaware where numerous Fortune 500 companies are incorporated. Other states are “non-permissive”, providing, for example, that a two-thirds vote is needed regardless of the matter to be voted on.
I am no longer surprised when I read advertisements in the Wall Street Journal like the ones by Walter B. Hewlett, of Hewlett-Packard fame. One particular advertisement read, among other things, “A $25 billion mistake is not the H-P way” and “Vote against the proposed Compaq transaction.”
Mr. Hewlett is trying to convince other Hewlett-Packard shareholders not to back up the transaction that the CEO, Carly Fiorina, planned to carry out. In practice, Mr. Hewlett is engaging in a so called “proxy fight”. What I find extremely interesting about proxy fights in the U.S. is that they target not only directors, officers, and institutional investors but also (and mostly) small investors and shareholders with marginal stakes. It is my opinion that U.S. corporate law is structured to include a vast number of shareholders in the decisions made at shareholders’ meetings. Thus U.S. law involves a much greater number of shareholders in the decision-making process than does the law of Italy. In fact, Section 7.25(a) of the Revised Model Business Corporations Act sets a quorum of 50% of the shares eligible to vote to be present either in person or through valid proxies at shareholders’ meetings. In addition to that, it requires a majority in favor of an action in order to pass. In some states it requires a majority of all shares present while in other states it requires a majority of all votes that did not abstain. This is because Section 7.25(a) has an opt out provision regarding abstaining shareholders at meetings. Many statutes allow articles of incorporation to set lower or higher quorums, but no matter how low the quorum might be, in the U.S. there is generally a greater participation of minority shareholders in the meetings than in Italy. The fixed quorum provision constitutes a dramatic difference between the Italian and American systems that considerably affects the strategies of corporate governance in the two countries.
In Italy, a controlling shareholder can easily appoint the members of the board of directors and approve or reject important deals with a much smaller number of shares than in the U.S. Actually in the U.S. a higher number of stockholders is involved in the decision-making process due to the high quorum and the well-developed proxy solicitation rules.
This concise paper focuses solely on meetings of holders of the outstanding common stock, leaving aside the special meetings of preferred classes of stock.
As mentioned above, in the U.S. shareholders’ actions normally cannot be taken unless a quorum of at least half of the total shares is represented at the meeting and a majority of the shares or the voting shares (depending on the state) is reached. The main distinguishing feature of U.S. law is, unlike Italy, the lack of distinction between the first and the second convocation of shareholder’s meetings.
In Italy two different kinds of shareholders’ meeting exist: (1) the ordinary meeting, assemblea ordinaria, and (2) the extraordinary meeting, assemblea straodinaria. The latter type of meeting is called for in the event that modifications of the charter of incorporation, issuance of bonds, nomination of liquidators are needed. The former type of meeting is called for in case all the matters not discussed at the extraordinary meeting have to be decided (e.g., the appointment of directors).
The core issue is not the presence of two different types of meetings, since in the U.S. most of the articles of incorporation include higher quorums when special and sensitive decisions have to be voted on, e.g., sale of substantially all assets, thus creating two or more kinds of meetings too. For our purposes, the most important rule is that in the eventuality the required quorum is not met at the first scheduled meeting, the Civil Code provides that a second shareholder meeting must be called for. According to Article 2368 of the Civil Code, in an ordinary meeting (1) at the first convocation, at least 50% of the shares eligible to vote have to be represented and at least a majority of those shares has to support action (2) at the second convocation no quorum is needed besides a vote by a majority of the shares present, and any provision of the articles of incorporation imposing a quorum is automatically null and void.
As per Article 2369 of the Civil Code, at extraordinary meetings (1) the vote of a majority of all shares eligible to vote is required in the first convocation and (2) the vote of more than a third in the second convocation, unless otherwise provided by the articles of incorporation, except for some specific decisions where 50% of the shares are required also in the second convocation. In listed companies those quorums are different; in fact, no matter the convocation, the presence of one-fifth of the shares eligible to vote is compulsory (unless the charter of incorporation sets a higher quorum) along with a vote of at minimum two-thirds of the shares present; moreover, for listed companies a third convocation is available.
A system of quorums that vary depending on the convocation does not exist in the U.S., and for this reason proxies are the indispensable instruments for the decision-making process, particularly in the publicly-held corporations listed in the New York Stock Exchange.
For a better understanding of the difference, let’s look at this example: shareholder A holds a 10% stake in an Italian corporation. Provided that at the first convocation of an ordinary meeting the required quorum has not been met, as it happens very often, shareholder A shows up at the second convocation of the shareholders’ meeting where shareholders B and C are present too. B and C own 4% of the stock each. In total, 18% of the shares are represented (A’s 10% plus B’s and C’s 4% each). This scenario would allow A to pass or reject any proposal listed in meeting’s notice.
In America this outcome is not likely. So, unless a lower quorum is set, shareholder A normally would need to have 50% of the stock at the shareholders’ meeting to take action. This in turn means that he would need to solicit a great deal of proxies, and it would require A to send the mandatory disclosure and informational documents to any shareholder he solicits a proxy from. B and C would then start sending proxies if they believe that they can outnumber A, and this in turn would benefit the corporation because decisions are taken in a informed way and involve a high number of participants. This is because small shareholders and investors, even if indirectly and passively, play a needed role.
For the sake of accuracy, it cannot be neglected that the New York Stock Exchange (NYSE) and the Nasdaq have adopted rules that allow articles of incorporation to reduce the required quorums. The NYSE has adopted Rule 310 of the Listed Company Manual stating that:
The Exchange is of the opinion that the quorum required for any meeting of the holders of common stock should be sufficiently high to insure a representative vote. In authorizing listing (whether original listing or listing of additional securities), the Exchange gives careful consideration to provisions fixing any proportion less than a majority of the outstanding shares as the quorum for shareholders’ meetings. In general, the Exchange has not objected to reasonably lesser quorum requirements in cases where the companies have agreed to make general proxy solicitations for future meetings of shareholders.
The Nasdaq passed Rule 4310.25(e) that reads:
Each issuer shall provide for a quorum as specified in its by-laws for any meeting of the holders of common stock; provided, however, that in no case shall such quorum be less than 33 1/3 percent of the outstanding shares of the company’s common voting stock.
Even if these provisions set lower quorums than the ones suggested by the RMBCA and the MBCA, they nonetheless entail the participation of numerous shareholders: (1) in a company listed in the NYSE, shareholder A would need to solicit proxies, since the Exchange has agreed to reasonably reduce the quorums only where a company consents to make general proxy solicitations for future meetings of shareholders, (as in the case of H-P) and (2) in a corporation traded on the Nasdaq, the quorum has to be over one-third of the outstanding common stock, thus implying a proxy solicitation most of the time.
In order to better understand the shareholder’s voting mechanics is essential to explain the meaning of the terms proxy and solicitation . The proxy is a document whereby a shareholder appoints someone to cast his vote for one or more specified actions. Except in rare cases where the management directly controls a majority of the voting shares a corporation cannot function without a proxy solicitation.
The Securities and Exchange Commission (SEC), the equivalent of the Italian Consob, has passed Rule 14-1(a), which defines a proxy in such broad terms to include “every proxy consent or authorization.” A proxy does not have to be written, and a shareholder’s oral consent to a request will suffice. The proxy document is normally a dated sheet of paper containing very specific contents that the shareholder signs and on which he manifests his vote. The term solicitation is defined by SEC Rule 15a-1(k) as any method of “furnishing … a form of proxy or other communication to security holders under circumstances reasonably calculated to result in the procurement, withholding, or revocation of a proxy”; thus an oral request or advertising are considered a solicitation.
It is worthwhile to consider the meaning of a proxy solicitation because once a corporation whose stock, as in the case of H-P, is registered under Section 12 of the Securities Exchange Act of 1934 decides to solicit proxies, it must observe extensive filing and disclosure requirements. The main requirement is the filing of any document to be transmitted to shareholders with the SEC, which will review the materials supplied and will order revision if deemed necessary. In addition to the proxy document, it is compulsory to submit to shareholders a “proxy statement” that must disclose, among other things, 1) conflicts of interest, 2) a detailed description of any compensation plan to be voted for, 3) a precise explanation of the major corporate changes, 4) disclosure of the compensation plans of the five officers that receive the highest salaries (because almost always proxies are solicited by the management of the company). In addition to this information an annual report must be sent to shareholders.
The procedure described above has to be strictly respected, and, in order to reduce the number of violations, the SEC has adopted a general anti-fraud provision: Rule 14a-9(a). It proscribes the use of “false or misleading information with respect to any material fact” or the omission to state any “material fact necessary in order to make the statements therein not false and misleading.” In case of violation of this rule, a shareholder has the right to bring a private action, even if he actually has not relied upon the information given, thus making the drafting of proxies a complex and meticulous task for lawyers.
Also, the Italian legislator has adopted rules similar to the American ones; in fact, there are specific provisions dealing with listed companies’ proxy rules. The legal framework is supplied by Articles 136-144 of the Testo Unico delle disposizioni in materia di intermediazione finanziaria, D.Lgs. 24-2-1998, n. 58, which allows a shareholder to appoint an agent to solicit proxies. Of course a more thorough study of Italian proxy solicitation rules would show many divergences, but for our purposes it suffices to say that Italian rules do not differ too much from the American ones. The solicitation requires two documents: (1) a prospectus for informational purposes and (2) a form that constitutes the delegating document. Both the agent that solicited the proxies and his principal, the shareholder, are liable for the information’s veracity.
For the reasons mentioned above, in my opinion shareholders with small holdings in U.S. stock are more aware of the affairs of the corporations in which they own stock due to the amount of information and data disclosed and disseminated by proxy solicitors engaging in proxy fights. The U.S. legal system allows shareholders to make decisions in a fairly rational way and in an environment characterized by a substantial flow of information, the truth of which sometimes is questionable. This however is another topic.
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