Fiduciary breaches, empty voting

Welcome to shareholder Primacy from free flow media. Podcast about activist investing Securities Law, and all the ways, the financial and legal worlds, intersect and Collide in real life. I'm here with and Lipton law professor at Tulane in New Orleans who teaches and researches Securities and business law, she holds up. Of course, the legal end of our podcast and that's Mike Levin and activist investor who lives and works in Chicago. He covers the financial side of our podcast. Yes, I do this week. Let's talk about some problems in m&a. Specifically, when an acquirer, a bitter tries to say, take advantage of conflicts of interest, among its Target companies, officers and directors, there's plenty of conflicts that exist there. And I guess they can make life interesting for, for a proposed to choir. Yeah. So and yeah, This time to look at the recent empty voting situation involving mass and activist investor. Yes, that'll be fun to talk about as well. So Um, I take it. There's some newer newer, newer issues that have come up in Delaware. Our favorite jurisdiction. Yeah. About in m&a, about acquiring companies, that try to somehow exert some leverage or take advantage over their target by looking at problems with Independence and conflicts of interest and so forth, among the officers and directors of the target target company, and this is becomes relevant to activists. Of course, because frequently, we're agitating for a deal. We, you know, that's actually there's a lot of evidence that the most value in an activist situation comes when you're activist portfolio. Company gets gets acquired, so I'm really kind of curious to sort of see where, what the latest here is. So what's what's going on? Okay, well just, you know, the background is, you know, corporate managers, I mean, just sort of the basics of the corporate managers the officers and directors they have, as you know, fiduciary obligations to act. In good faith to maximize shareholder. Well, fiduciary duty, yes, fiduciary duty, but there is also a concept of aiding and abetting of fiduciary breach, so that's when someone they're not a fiduciary, they're not a board member, they're not an officer, but they somehow participate in or induce a fiduciary breach by someone who does have fiduciary obligations. And when that happens, shareholders can sue. That person who aided or induced the fiduciary breach just like they can sue the breaching officer of directors. So, here's an example. If I went out and I bribed to CEO to get him to direct his company's business, to me to sign a contract with me, the CEO has breached his duty of loyalty. He acted to pursue his own interests by taking his bride. And I, as the person who bribed him, I ate it in a bed at that breach. And I could be liable to shareholders for the breach of loyalty right along with him, liable to shareholders of that CEOs company. Exactly, exactly. Okay. So this is, that is a very old That's traditional agency law, that's black, letter agency, law, what Delaware is dealing with now is at what point? Does, how does that play out when we're talking about and not somebody who, like, bribes the CEO to get a contract, but in acquiring company, who is, you know, sort of trying to create conflicts, or take advantage of conflicts among the board in order to get them to sell to that acquirer? Oh, wow. All right. Go ahead. So, like, let's play a game. I'm gonna do this as if I were teaching you and you were a student in my class. So, okay, I mean in your which class Security's law, well, this would be, actually, this would be just basic resource, or maybe Eminem's. Okay. And my first second, third year student, is this a big black shirt. Do you know who I am? I know who you are, cuz I'm calling on you. So, okay, great. We'll start, I'm gonna acquire. And we've, as we said, if I go out and bribe the CEO of a Target to get them to rig a bidding process for me, and direct the company to MediaFire. If I go out and I sell the CEO, I'm gonna pay you 100,000 dollars. If you make me the winning bidder, then for sure I've made it that CEO. Just finished Shari breed. So let's just take that as a baseline. That is absolutely aiding and abetting breach. But now let's say I'm a private Equity Firm, but in stead of bribing the CEO, I just say, hey CEO. If we acquire your firm, you will work for us after the acquisition, okay? And we pay you based on performance metrics that are very, very easy to meet and you're gonna get huge bonuses. If you sell to me, is that aiding and abetting a fiduciary breach. I, I don't know. I would, I would, I probably could ask some questions that we don't have time for right here, but, um, Okay, so that's the setting is that but that's a really that's a really simple. That's me. Going to the CEO and saying, hey, if you sell to us, we'll hire you after. Now that's pretty obvious. You can see See that the CEO is conflicted. So what the private Equity Firm is a little bit more subtle. I don't say to the CEO, hey, will hire you after we buy your company, what I do is I make it a practice of hiring CEOs, after I buy their company. So, it's like a pattern, a pattern. So I make sure that the next CEO knows that's just so when, when, when, when me activist sees a PE firm getting involved in the Strategic review that I'm urging somebody to do and that PE from always or frequently as we say, a pattern hires the incumbent CEO and says okay you're safe and and we're going to make your life really kind of even a lot easier you know P forums usually as buyers are pretty tough. Yeah but in this case you're going to say okay if you if you kind of Stack it in our direction, we're going to make your life putting Kush. Yeah and we do that not by openly saying this is what we're going to promise you. They do that by showing just exactly so or or then you can get a little further out golden parachutes. The CEO is going to get a huge. Oh, shut up. He sells the company. That's the buyer that's coming from the target. I mean, that's something that the target actually created because they want to encourage CEOs to sell, but they can create these conflicts. And though, and so, if I'm the acquirer, I might specifically seek out companies where, I know that the CEO gets this huge, golden parachute. And I intentionally say, Hey, you know, that golden parachutes coming and don't you think you like to say? Yeah, so I know that they're thinking about that and I tried to exploit that. So this is these subtle sets of problems are what the Delaware Supreme Court is grappling with the Delilah chords of grappling Okay, so just to kind of recap, that's probably pretty straightforward. There's Arms, length kind of buyer. So we're about the Target that creates an environment. Either through past patterns, probably more through past patterns. It'd be pretty. Pretty easy there. They're smarter than to put all this and writing to try to essentially get and it doesn't have to be a CEO though. It tends to sound like it's mostly CEOs. It could be any directors. Yeah, officers were like, yeah. Anybody who controls the duty and its duty of loyalty, anybody goes that duty of loyalty. Under Delaware statute to the Target company, where we're kind of, we're kind of looking at some of the more subtle examples. Exactly how this works. Okay, so good. So there's a, I think there was a case now, right? Yeah, exactly. So that there was okay. So there's one case that was just decided it was just decided in December involved, the company called Mind Body and there was a private you. So I saw the caption, I I didn't I didn't read the case, so I was waiting to I was waiting for that class. It's marvelous, marvelous facts. There was a private Equity, buyer Vista, and a CEO who really wanted a big payday because he couldn't sell his like he had never gotten a big payoff for a shares. He had all these shares, he had a 1051 plan and they were limiting how much he could sell it. Any particular time, one playing with the plans where they can insiders consult on the schedule. Yeah, exactly. But he Drinks. Trying to. Draw like he really wanted to play, but he really wanted to dip his Beak. He didn't want to. so, so So the buyer Vista, invites him to attend a conference that Vista was sponsoring where he could see all the other CEOs, talking about how great a buyer Vista is like, if about a Vista bought your company, you would get all of this money from essentially the performance of the company post post acquisition. So the company. So this is like recruiting to like a country club, not like buying a company. Okay. So of course the CEO becomes very excited about selling to Vista and when mine body starts running a sale process under the CEOs Direction, the CEOs, like back channeling information to Vista, which puts Vista in this position to get a leg up on the beds. The CEO ends up, they signed a deal and there's a ghost shop and the CEO is so entirely uninterested in the ghost shop or finding alternative acquirers that halfway through the ghost shop. He goes on vacation to Costa Rica. Wow. So, he's running the sale process, no one can find him. Exactly. Know if anything happens goodbye. So the shareholders too unsurprisingly saying that this CEO didn't maximize value for shareholders and they claim both the CEO violated his fiduciary duties. And also that this stuff that the private Equity buyer aided and abetted these fiduciary breaches. Sure. But there was a procedural wincle, by the time it gets to trial before Chancellor McCormick. So if your favorite couple of changes, it goes to travel before Chancellor McCormick, the whole issue obviously is whether Vista corrupted, the sales process. But there's also an argument that the proxy statement was misleading because the proxy left out all these details like their shareholder voting. You kind of want to know that your CEO is a Costa Rica. Yeah. So the proxy statement was misleading because it left out all of these details and that's its own fiduciary brief. So the sales process is a fiduciary breach and the false proxies of fiduciary breach, whatever reason, I don't know what happens. Somehow the plane is end up only arguing that Vista aided, the proxy disclosure breaches, they don't somehow maintain a claim that Vista aided the sales process part. So when it goes to the Delaware, Supreme Court, the Delaware Supreme Court, holds, whatever else Vista did, or didn't do it. Didn't Aid in a bed, the disclosure breach, because to Aid of a new Sherry Bridge, you have to have actively participated in some way and it's not aiding if you just Sit back and watch. You have to actually cultivate a breach and here the proxy materials weren't drafted by Vista. They were drafted by this CEO the merger documents how to kind of standard Clause that said Vista was supposed to notify the company. If there were any false statements in the proxy but the Delaware Supreme Court said that's just not good enough Vista. We're not considering whether Vista aided a sales process. Breach we're only considering whether it aided the disclosure breach and sitting back and watching the CEO. Not disclose enough is not what was sufficient for at least for the Delaware Supreme Court. It's not cold Vista. In some sense, reliable responsible, and liable for this particular breach of exactly for this for aiding abetting, okay? For aiding in a wedding. So the CEOs, on hook both for the sales process and for the foxy. But Vista is off the Entirely. But we don't know because the Delaware Supreme Court didn't have to get to and no court up, get to whether Vista could have been held liable for aiding the sales process for each, the fact that he wasn't running the process to really maximize value for shareholders. So that's, that was the Mind Body case again, and we saw the caption come out and a pet just in the past few weeks. I think. Yeah, I came on December, was there, is there other similar? Yeah, so there's got me another similar cases here. Yeah, exactly. So there's one more that's pending before the Delaware Supreme Court, and it's going to be decided, you know, sometimes it hasn't even been argued yet. It'll be decided in 2025 and this is the Columbia pipeline case. So the CEO and the CFO of Columbia pipeline, they both were older, they wanted to get their golden parachutes, Change Control benefits in retire, and it's kind of this complicated set of facts. The parties are still arguing really about what actually happened. But essentially these two guys favored, trance Canada's bid for Columbia pipeline because they thought it was high enough to be credible. All they could close quickly, they didn't want to bargain because they just wanted out and get their change of control benefits. And the allegation, the claim here is that TransCanada knew all this TransCanada. Could see that these guys were favoring them, they were giving them internal bargaining points. They were getting ahead of the board. There's a whole thing where TransCanada kept reaching a standstill and these guys ignored it and let them keep reaching the stand. Still, even though other bidders were still locked up. So basically transcended knows it's being favored and eventually TransCanada reaches an agreement in principal for 26 dollars, a share and then we don't know how there's a leak about these negotiations and that leak puts a lot of pressure on the company to finalize. The deal at that point, TransCanada threatens to publicly announce that the negotiation have ended, which would have violated the stamp Stills unless Columbia pipeline agrees to lower the price from 2016 to 2550 and Columbia pipeline agrees. Accepts this lower bid, they had a sort of handshake deal on 26. Columbia pipeline says, okay, you're threatening us will make a 2550 and that's the point. Laster says, the TransCanada crossed the line into aiding and abetting, because up until then what it had done, was sort of, cultivated a kind of plei. And these two officers, it knew these offices were compromised. It pressed them with these standstill breaches it, manipulated them into position, and then it all came to a head when TransCanada, kind of exploited, their eagerness to sell with this threat lowering the price. So there was some more. So there was some very definable damages, it looks like, that's exactly what he did that last year. Concluded that this drop in price, was the was it was, was, was in fact, the damages. So, but there's a real question. Like that's why they're building trucks. Kind of saying this is not a fiduciary. Breach, this is sharp bargaining. We we made it. Was you knew that these guys weren't really bargaining on behalf of the company and you exploited that to get that to pressure them to accept a lower price and that is sort of where we are and we'll see if the debt what the Delaware Supreme Court. So he then awarded He found in favor of the plaintiffs and this Columbia pipeline one. Exactly got it. So that's why Trans Canada is appealing that I think that officers actually settled. All right? So And Mind Body. Mind Body is done my body's done but only with respect to that question. About disclosure we got no ruling. So now with Columbia pipeline does, is it presents an the ability for the court to start talking seriously about when is it aiding and abetting for the actual whole run of the process, Okay. And all the different in all the different ways and forms of VC a buyer. Some sort of third party arms length bid or whatever can interfere or somehow create or encourage a breach of fiduciary duty. Exactly. Oh, wow. So that'll be that'll be and that'll be later. Know. Yeah, yeah. Well, we're recording this at the very end of December. But yeah. So this will be, you know, like, you know, a couple months into 2025 so it'll happen pretty quick. Yeah, and I mean, I'll just, I'll just say that. Like, the reason this fascinates me is, like, obviously, there's this nitty-gritty, question of, like, what's the line between like sharp dealing and like, bribing the officer like it's it's really hard to figure out where some of those lines are. But there's actually this bigger meta issue we have said repeatedly on this podcast so there's all this turmoil about whether Delaware's being too strict in its governance standards. Whether it's imposing too, many constraints and corporate managers and the issue. Is that Delaware has I think I think Delaware's developed a set of legal standards that don't mesh very well with the practices that have grown up around venture capital and private equity. And I think that these cases are sort of the continuation of that problem. So TransCanada is not a private Equity case. That's like just normalized body certainly was that but mind body was and the TransCanada issues are PE issues on this golden parachute problem. That's exactly what PE does. They look for companies that have CEOs with golden parachutes and they try to exploit that and they couple that with exactly what Vista did. Look at how well we treat our CEOs. Don't you want to us? That's industry practice. So, I think this entire line of cases involving aiding and abetting, you know, it actually got started several years ago, when investment Banks were found to have aided fiduciary breaches mostly in the context of pebbs. So now we have these other cases that are all. So raising questions about some private Equity standard practices and I think this is running a running theme in Delaware of how much Delaware sort of Well-developed body of case law was really not designed for the you know, the private or at least or at least how the PE world has kind of evolved in exactly recent past. Exactly. Exactly. So this is just one example. Director Independence control. There's all those issues are basically. Shareholder agreements. These are all issues that are like developed in the piece and now they're running smack into Delaware law or Delaware's. Allowed goal of helping protect shareholders exactly in this in this way? Well, that's that's Interesting. So Professor, how do I do? I just want to pass, I just want to go and please anyway. So speaking of winter break and breaks, let's take one of those Shareholder Primacy is brought to you by free float and lyrics.com the only free database of corporate directors their influence and their performance. If you own a stock or retirement plan go to free float, analytics.com and look up which of your elected directors are performing well and which aren't use your vote in the alternative democracy and get your data at free. Float analytics.com. Now, back to the show, Welcome back to. See, I'm lifting here with Mike Levin. So Mike we talked before about buying boats and now we've kind of seen this sort of poor relationship and a really dramatic example of it. So what was going on with Massimo and pollen Capital? Well, it was a wonderful example. Of of empty voting, which is defined in some way. There's no really great definition of it, but it's sort of, you know, voting shares where you don't have the underlying economic ownership of the shares, and there's all sorts of different ways. People thought about it, we've talked about that a little bit in the past, but this activist situation really brought it home in some really fascinating ways and of course involved masimo Corporation a tech company that in fact sells the Blood oxygen monitors to Apple for Apple watches. Famously, secretive famously competitive CEO. Joe keoni was a Visionary in this little bit of bio-technology. Anyway, so they got in the radar of pilot and capital, Clinton coffee guy. We know who in 2023, succeeded in winning a proxy vote for two out of the six seats on a classified board. So, not Quentin, but two other people. So, he's not where were two of his nominees were on the board at Massimo, at the 2023, annual shelter meeting. And then instead of sort of just settling there, Quentin's a, pretty ambitious, and pretty clever, dude, he also because he won his seats in an outright election. There was no standstill agreement. There was no settlement, there was no nothing. He could do what he wanted. And he was clearly not happy with the direction of the company. Even with two out of six seats and so early in 2024, he duly noticed and nominated two other candidates including himself and one of the person. And so if this succeeded and for people would control the six-person board and clearly that made Joanie a little nervous. So some things started to happen. So after you could do is run the company better, take advice or, or you could do what he did, which was try to try and some would have evidently some very underhanded ways to try to make sure cough or try to help coffee lose this pot and lose this. So what they did it wasn't quite clear until only a couple months. The annual meeting was in, I think May and it wasn't quite clear until several months later. Exactly what I'm about to describe happened, but in the meantime pollen, capital is running this proxy contest, they got, you know, proxy materials out and they're counting votes and right away. Pilot and started noticing some weird stuff. So so glass Lewis came out with his voting recommendation to support the coffee. The pilot nominees and in its report said, it looks like there's some shareholder that is really urging us to make our recommendation a certain way and saying they own shares that they don't, they were not sure they owned. okay and so there was there was some funny business going on and pollen issued, a news release like sometime in May saying we urge the company to sort of investigate this Um, and that sort of, you know, not the company sort of responded said, you're crazy. We're above board. Interestingly the AGM got moved For whatever reason. Which we found out a little later. The so our companies are poking around and yes, after and they said, we we think there's some examples, empty voting going on, we don't really know. But we really want the board to investigate. We really urge the company to move the annual meeting and declare a new record date. And the company ended up doing that. And so, the AGM ended up moving to September. In September pile and his two nominees win. And so Quentin coffee in another person. Get on the board. And right away, some really interesting things happened. Very quickly. Joe, can he CEO leaves with him and everyone starts threatening to each other? But that's kind of all we know. And then I will say that just have to point out that normally, when I teach students about staggered boards, I tell them, it's kind of impossible to win like, you know, to take, you know, successfully win, two year, two success for us, we contest like that. It hadn't ever been like that, you know, really possible. So the fact that I mean, I think with it's probably still true when you're talking about somebody who wants to acquire a company because you can't wait that long I think like but as an activist you know just wants to sort of take over in a different way. He really could invest in Winchester, the showed extraordinary, patience and fortitude. It also helped that he already had two people on the board before who were able to report because it was not a settlement because they wanted an outright election, they could sort of selling anything wanted they could tell, you know, get, you know, share all sorts of information with pilot and with, so on and so forth. So, it clearly made it a lot easier for pollen to win these Ron. A second contact, it also helped that, you know, keani was, you know, famously standoffish to shareholders and so forth. So Anyway, so we saw, you know we kind of everyone in the activist Community kind of suspected. There was his empty voting going but we really didn't know until until A couple of lawsuits came out. The second lawsuit which we don't need to talk about is pilot and was soon is continues to sue kyani over his golden parachute know, which is just so fantastic. Because this hat, this happened a couple times where like somebody, you know, wins the contest and then Sue's right everybody like who resisted, I mean, like taking over a company and then suing the people who sort of major life difficult. Well, Elon Musk it delicious to buy well, Elon Musk suing watel because he was forced to buy Twitter, I think. Yeah. Carl Icahn wants be like, you know, took over a company over their resistance and then sued all the former right? The former exactly. I mean, you know, it's a very, you know, like it's great the people who you fought with before is just delicious Revenge anyway. So the second lawsuit again was against Keanu because I can't remember if that was a counter Sue River but they're suing over his severns back the first one revealed a lot. And the facts, and the allegations were fascinating. The second, the first lawsuit is against keani, but also against this investor, it's called rtw Capitol, which is a good friend of Keanu, he's on their website selling managers and he's been a guest at their conferences and so forth and the facts in the complaint at least revealed a lot more. What was going on? um, it revealed that the first time when the annual meeting was in May that kyani had divulged the record date to rtw. Rtw at that point had owned a little under 3% of the common. And quickly. Increased their exposure to just under 10% just under a couple disclosure thresholds. And at the same time, put on shorts for the increase in their position, which, you know, on the one hand is just responsible portfolio Management. On the other hand, sort of betrays, a little bit of a lack of confidence in kyani. I mean, if you complete short, yeah, if you completely just bought shares and completely got rid of all your economic interests, and that's just straight up, that is the definition of a devoting, right? And then, and then a week later, they sold all the shares reverse, the short, and after voting, the shares, And then then the meeting got postponed. That's what so that first instance is what pile and its proxy solicitor has started to detected in and the facts in the complaint is a great read here. I don't read many of these because I'm not a lawyer but there's some really good right now so so they Unwound on the shorts and then had to go do it all over again. Because the meeting got moved to September. So they tried to, they did it again. They didn't even after they got caught, they had to move the record day because they got caught and they did it again. And again, they didn't actually kind of get caught. They were kind of accused but then they did it again. And even then Pilate and prevailed in the in the other thing they both engaged in devoting and did it. So even with Probably 15 or 16% between keani and rtw Z, empty vote. And the empty voting of course, was the I was how pallet was rtw, Voting shares, you know, voting 10% of shares, only 3%, so the 2%. So the the 7% was kind of empty. Anyway, so you're so pilate and then sued rtw, but the lawsuits interesting. The, the accusation is only kind of two kind of basic claims in or accusations this the second had to do with short swing profits. Basically they they formed a group or they were accused of going over the short-term profit threshold and because can't he's inside her and rtw was Affiliated. They said, we don't know what the amount of short spring profits are and you have to do that anytime you're trading on. A ya, on a short time frame, if you make money, you got to give money to the company, got right? So, right so Kiana is inside her, and the idea is, so the accusations, they bite, creating this empty, voting scheme, sort of coordinated with rt, You the two of them became a group and as a group that I think owned more than 10% together. Yes, and that's and Kean is also an Insider they are subject to. The short swing profit rule that says, you have to discourage any law profits made or losses avoided if you rapidly buy and sell within a six-month period. So it's their conspiracy. Made them all one and subject to this rule, right? And so, the first allegation that was able to enable. This was, they formed a group. They grew that they did not disclose they were coordinating, right? Like coordinating, they formed a group. They didn't disclose that was a group and that's its own SEC violation. And that's the one that again, Elon Musk is being Super right when he bought Twitter. He said he filed the Gene's that have a d. Yeah. So, not disclosing that they were this group and then simultaneously, I guess, because they were a group, not discouraging their shirts. Correct. So those are the two kinds of accusations in the, in the case, the case obviously, there's going to go to Discovery and they're going to do all things at cases do until they possibly settle. But interesting, a settlement isn't going to amount to much here. You know the penalties this is about revenge. Yeah, right this. Well, it's interesting. Is that so that settlement of the 13d, you know, failure, former group, normally, if there's a 13 D violation, that's a disclosure problem. And then the response, that's more, just a little fine from the SEC. It's actually not really enforceable by like private, you know, I think that is really, that's not going to be profit, is gonna be alive and even the shares didn't move on. I mean, this is just anger, right? Well, interestingly there's two other points I want to make. First the at no point at least in the legal arguments here, is anyone saying that empty voting is illegal? Because nobody knows. It's so clear, right? Yeah. So but there's no, there's no accusation that the actual Act of trying to vote shares. You don't own was appropriate, broke some law. Yeah, no Delaware, there's federal law against it in. Delaware really tries to avoid ruling because it's so hard to figure out to do. So, we have another, you know, a very clear example of someone buying and selling vote's basically, where we're not going to get any kind of legal. No legal ruling about whether. And the second thing is, is all this took place after pilot and won the first round, the second, the second round one the majority. Yeah. I mean, all the facts in this, in this, in this complaint, everything that we learned about the empty voting and how many Shares that are and who would rtw was doing it and how they knew each other. This wasn't because there was some sort of Discovery process. This is because Quentin coffee was on the board. It was able to get like Joe Kenney cell phone records. And and all starts to internal emails and Communications and there's in the complaint, there's like this photograph of account of votes, as they're coming in of a whiteboard, this was company records. Oh, that's fantastic. And and and and, you know, clearly know, it's on a criminal conspiracy. Exactly found all this and said, oh man, this this complaint kind of writes itself. That's what so anyway. So, um, I'm again, I'm, you know, very intrigued or we should we, are, we all are intrigued in how these kind of voting things kind of work, and, you know, some of the legality were we'd loved for Delaware to kind of rule on this, but unfortunately, it's not gonna happen. This is this is all federal At this point because this both the short swing profit and the 13d violations are all federal statute and but we'll have to see what happens there. So, that was, that was the most recent fund, example of, of empty voting and and kind of, you know, again I commend the, the complaint, the facts, and the complaint it's pretty to all everyone listening here. It's really it's really kind of cool. Yeah. So so that was that was what happened at Massimo and with with so right, isn't it? Um, I think I think we've had enough of this. I think that's terrific talking. Once again this is shareholder Primacy hosted by and Lipton and me Mike Levin. I'm an activist investor and advisory to investors about their activist situations, and is the Michael Implement professor, in business line entrepreneurship at Tulane law, school and affiliated. You can find me Mike at the activist investor.com. And Anne at two lane.edu. Our podcast is producing distributed by free. Float media. Thanks for listening. We will talk again.