By Keith L. Johnson and Andrew Clearfield
A preliminary ruling in a pending shareholder suit contesting News Corp.'s extension of its poison pill already has established a critical Delaware law precedent that upholds the authority of shareholders to resolve corporate governance issues through negotiation of board policies that will be enforced by the courts.
The case also has sent a message to other public companies that investors will not tolerate breach of agreements involving shareholder rights. Participation in the News Corp. suit by a dozen institutional shareholders from around the world helped highlight the importance of the issue for the court and overcome the company's attempt to portray the lawsuit as the frivolous protest of a fringe element.
The case had its origin in the effort by News Corp. to reincorporate to Delaware from Australia in fall 2004. That move was opposed by many of the company's shareholders, particularly in Australia, because it would result in a loss of shareholder protections provided in Australian law. Under Delaware law, News Corp. would be able to adopt a poison pill without shareholder approval, while a shareholder vote would be required for an Australian corporation.
To obtain shareholder and court approval of the reincorporation, News Corp. negotiated an agreement with its objecting shareholders. The agreement resulted in the company's board adopting a policy regarding shareholder poison pill approval that was described in a letter sent to all shareholders and option holders on Oct. 7, 2004, prior to the shareholder vote on approval of the reincorporation.
Once reincorporated in Delaware, the News Corp. board adopted a poison pill when Liberty Media Corp. boosted its ownership to 17% of the company's stock. Despite the agreement to submit its poison pill to a shareholder vote within one year, News Corp. announced last August that its board had decided to extend the poison pill for two years without a shareholder vote.
A group of 12 shareholders from Australia, the Netherlands, England and the United States filed an action in Delaware last Oct. 7 to enforce the negotiated agreement and require a shareholder vote on the pill extension. Although the plaintiffs did not take a position on whether the pill extension should be approved, they were very concerned that allowing the violation to pass without challenge would waive shareholder rights to vote on future extensions and encourage other companies to ignore board policies adopted pursuant to negotiated corporate governance agreements.
News Corp. claimed in the litigation that it never agreed to not revoke the policy and that Delaware law allowed the board to unilaterally change it at any time. It asked the Delaware Chancery Court to throw out the lawsuit. The court rejected News Corp.'s argument, ruled that such an agreement can be enforceable and refused to dismiss the case in an opinion issued last Dec. 20. The case is set for trial in April.
The News Corp. situation also highlights several other, more fundamental, principles that might be of greater importance than the legal precedent.
First, collaboration between institutional investors on matters of mutual concern can achieve substantial benefits. The group of international investors was able to present a much more persuasive case than a single shareholder. Despite the substantial News Corp. institutional investor shareholder base in the United States, and the Delaware venue required for the litigation, the response to News Corp.'s treatment of shareholders was driven by non-U.S. investors. Only two of the 12 shareholder participants in the Delaware litigation are U.S. investors, and only one of those (the $22 billion State of Connecticut Retirement Plans and Trust Funds) is a major institution.
Long-term investors could benefit from development of an investor culture that prioritizes identification of and collaboration on the big-picture issues and interests they share. There is a cost, quite aptly illustrated by the current executive compensation situation in the United States, to maintaining a dominant "free rider" approach to issues of mutual investor concern. Excessive reliance on other investors to take action on systemic issues plays into the hands of competing interests and limits the ability of investors to obtain the additional economic and risk reduction benefits that could be produced by collaboration. The News Corp. case is a good example of the benefits of working together.
Second, many pension funds and other fiduciaries with long-term liabilities seem to have forgotten the fiduciary duty of impartiality that precludes unreasonably favoring older beneficiaries over younger ones. In the News Corp. case, a short-term view of the Liberty Media hostile takeover threat would have overlooked potential longer-term benefits involved in the lawsuit regarding (a) preservation of the bargained-for right to approve future extensions of a News Corp. poison pill and (b) avoiding a precedent of investor passivity that would encourage other companies to ignore negotiated board policies involving shareholder rights. Although they are harder to quantify, the long-term benefits are of substantial value to long-term investors.
Third, pension plan sponsors cannot expect investment managers that are evaluated based on market-relative performance over less than a full market cycle to take an interest in pursuing the long-term best interests of beneficial owners. This is especially so when the managers are not paid for or evaluated on accomplishment of long-term goals. The corporate community has complained for years that investors are driving companies to focus primarily on delivering short-term results at the expense of building sustainable wealth. If this is (and it should be) a concern to fiduciaries with long-term liabilities, plan sponsors and trustees are the ones in a position to respond. Efforts to balance sustainable wealth building with generation of short-term returns will not occur at the investment manager level under prevailing portfolio manager mandates. Either the investment manager mandates will have to be modified or plan sponsors and trustees will have to establish separate long-term issue overlay programs to balance generation of current returns with preservation of future economic wealth-building capacity for younger beneficiaries.
A healthy pension and corporate governance system requires that fiduciaries play a role as long-term owners. Collaboration among shareholders is one way to do that. Participants need not be the same players each time. As long as collaborators are not pursuing change of control and do not get sidetracked into micromanagement issues, long-term investors and their beneficiaries could benefit handsomely from devoting more efforts to collaboration with little risk. Rationalization of executive compensation, development of a stronger base of independent director candidates, requiring better investment research targeted to sustainable company performance issues, and evaluation of the long-term prospects of merger and acquisition transactions are all good collaboration candidates on which these efforts could start.
Keith L. Johnson, former chief legal counsel at the State of Wisconsin Investment Board, leads the institutional investor services group at Reinhart Boerner Van Deuren SC, a Wisconsin-based law firm. Andrew Clearfield, former international investment manager at TIAA-CREF, is president of Investment Initiatives LLC, Glen Ridge, N.J., which offers corporate governance consulting services, and a member of the board of governors of the International Corporate Governance Network, London.