Corporate Securities Law Blog

In In re Netsmart Technologies, Inc. Shareholders Litigation, C.A. No. 2536-VCS (Del. Ch. Mar. 14, 2007), Vice Chancellor Strine held that the shareholder plaintiffs demonstrated a probability of success on the merits of their claim that the Netsmart board of directors failed to fulfill their Revlon duties in considering and approving a cash sale of the company to two private equity firms.  The Court determined that the board’s decision not to conduct a broad market canvass for strategic acquirers, and instead focus the search for acquirers solely on private equity firms, did not appear to be reasonable under the circumstances.  The Court also held that the post-signing “market check” recommended by the company’s financial advisers was not appropriate for a small-cap company like Netsmart, thus was far too passive to have been effective in mitigating the narrowness of the pre-signing market canvass.  This decision provides guidance to boards when considering a sale to a private equity firm — an increasingly common situation affecting boards of directors of public companies throughout the country.

The SEC and PCAOB have taken significant new steps to implement promised reforms to the implementation of Section 404 of the Sarbanes-Oxley Act, which has been widely perceived to be unduly expensive and burdensome.  On May 23, 2007, the SEC approved new interpretive guidance for management’s assessment of internal controls, and amendments to certain Section 404 related rules.   The new guidance provides a principles-based framework intended to help public companies strengthen their internal control over financial reporting while reducing unnecessary costs, particularly for smaller companies.  On May 24, 2007, the PCAOB voted to adopt Auditing Standard No. 5 to replace its previous internal control auditing standard, Auditing Standard No. 2.

The SEC today announced that the staff would recommend an amendment to the proxy access rules to respond to the issues raised in AFSCME v. AIG, and scheduled an open meeting on October 18 to consider the recommendation. In making the announcement, the chairman of the SEC noted that shareholder rights in the proxy process "are best secured under a consistent national application of Rule 14a-8 to shareholder proposals" and that the SEC would schedule public comment and final consideration of the proposal "to allow a final rule to go into effect in time for the 2007 proxy season."

In AFSCME v. AIG, the Court of Appeals for the Second Circuit today provided a powerful impetus to the efforts of institutional shareholders to expand proxy access. The court’s decision does not directly grant shareholders the right to present their own slates of director nominees in the company’s proxy statement. However, it does challenge the long-standing interpretation of Rule 14a-8(i)(8) as permitting a company to exclude a shareholder proposal granting shareholders increased proxy access. If the SEC fails to respond to the court’s decision by clarifying or amending Rule 14a-8(i)(8), shareholder activists predict a surge in shareholder proposals to establish liberal proxy access procedures on a company-by-company basis.

The U.S. Sarbanes-Oxley Act of 2002 ("SOX") requires audit committees of public companies to establish procedures for the anonymous submission by employees of that company of concerns related to accounting and financial matters. Multinational corporations, however, have to be careful to consider data protection, labor and human rights legislation in the EU and other countries in the design of their whistleblower programs. 

In January 2006, the SEC staff rejected the argument of Hewlett-Packard Company that it could exclude from its proxy statement a stockholder proposal to adopt a majority vote standard in the election of directors. Hewlett-Packard had argued that it could exclude the proposal under the SEC proxy rules because its existing voting policy "substantially implemented" the proposal. At its annual meeting on March 15, 2006, 53.0% of the votes present voted against the proposal, 43.5% voted for the proposal and 3.5% abstained.

Senator Richard Alarcon (D: San Fernando Valley) has introduced a bill that would require a company incorporated in California to elect directors by a majority of the votes cast in an uncontested election. The bill codifies a majority vote standard similar to those already adopted by Intel Corporation, Dell Inc., PepsiCo, Inc., Texas Instruments and others.

Two standards are emerging in the push to replace the current plurality vote standard in the election of directors.