January 19, 2012

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Up in Smoke

What rights do shareholders have when a company crashes?

Gretta Spendlove

January 19, 2012

On April 20, 2010, an explosion on a BP offshore drilling rig created a massive oil leak into the Gulf of Mexico. Just 17 days later, on May 7, 2010, a BP shareholder sued members of the BP board of directors, claiming that the board’s pursuit of profits at the expense of safety led to an oil spill that could cost the company billions of dollars. The lawsuit seeks not only money damages, but also changes to board structure and membership. Since May 20, 2010, BP stock has plummeted further, spawning ever more shareholder claims and lawsuits. As public companies careen through the Great Recession, shareholders holding devalued stock consider their options. Those options include shareholder derivative lawsuits or corporate activism. Shareholder Litigation In a shareholder derivative lawsuit, a shareholder acts on behalf of the company against a third party, such as a corporate officer or director. In the BP case, the shareholder suing in May 2010 brought an action in the name of BP, claiming the board of directors had harmed the corporation. Many shareholder derivative lawsuits are certified as class actions, with lead plaintiffs represented by lead attorneys, eventually representing most or all of the shareholders in the company. How much can shareholders obtain in damages? Historically, shareholder derivative lawsuits have not resulted in huge payouts, but rather in remedial measures, such as change of board members, attorneys’ fees and a limited payout. Since the lawsuit is against third parties, rather than the company itself, the availability of damages is often limited by the upper limits on directors and officers liability insurance policies. In class action lawsuits, any payout is spread across the entire class, further limiting the amount of recovery per class member. However, in the BP case, more money may be available because shareholders have sued not only board members, but other companies which may have harmed BP, such as the companies that provided drilling services and owned the drilling rig that exploded. How long does it take to obtain damages or corporate change through a shareholder’s derivative lawsuit? “I’ve handled shareholder lawsuits which settled within a year, and others which dragged on for several years,” says Brent Baker, a Salt Lake lawyer specializing in securities litigation. Many lawsuits against large public companies, such as BP, Goldman Sachs or AIG, are brought in New York or California, but the shareholders may be from anywhere. Baker once represented a Park City resident in a shareholder derivative suit against a major company. He is licensed in New York and brought his last two shareholders derivative lawsuits there. Lawsuit Due Diligence “Shareholder litigation is not fast and it is rarely satisfying for the parties,” Baker says. Shareholders who want to sue a company like BP, whose woes are in the news, should research both the company they want to sue and the attorney they want to retain. Company information is available from the Edgar database on the SEC.gov website. “Advertisements for participation in shareholders derivative suits have traditionally been published in the Wall Street Journal,” Baker says. “But the Internet is a great equalizer. Go to websites for the lawsuits and lawyers involved, read CVs, and check to make sure the lawyer has securities experience and doesn’t have Bar complaints.” Baker mentions the furor a few years ago when attorneys from Milberg Weiss, a prominent law firm representing plaintiffs in derivative lawsuits, were criminally convicted for paying their plaintiffs millions of dollars in illegal kickbacks. Baker also suggests going with local attorneys when possible. “New York attorneys charge up to $1,000 per hour. Utah attorneys charge half that, or less, and many are very skilled and sophisticated.” Changing the Board “Rather than seeking change through the courtroom, seeking change through the boardroom may be a better long-range solution,” says Josh Little, a St. George attorney with corporate clients throughout the Western United States. Since boards of directors are responsible for appointing and overseeing officers, and boards are elected by shareholders, the shareholders, working together, can influence who runs the company. “In the past, staggered boards and plurality voting for directors were very common,” Little says, “but that’s changing.” With staggered boards, directors are elected for multi-year terms, a few per year. Shareholders trying to change the composition of the board thus have to win proxy fights for two or three years, rather than just once. With plurality voting, the directors who get the most votes win, even if none receive a majority vote. A change to a declassified, or non-staggered board, and majority, rather than plurality, voting can impact what is required to change the board. Shareholder Proposals “SEC regulations contain a process for shareholders to make proposals to be considered at annual meetings of shareholders,” Little points out. “Many recent changes in corporate governance have come as a result of shareholders’ proposals being considered at annual meetings.” Some of those proposals have greatly increased shareholder power. Home Depot and Coca-Cola recently opposed shareholder proposals to hold nonbinding votes on executive compensation at future shareholders meetings. One California retiree, John Chevedden, has become a well-known shareholder activist by presenting shareholder proposals to companies as diverse as General Electric, Bank of America, Ford and Hewlett-Packard. He has recommended separating the roles of CEO and chairman, adopting majority voting, and giving shareholders the right to call special meetings when 10 percent of shareholders think it’s necessary. When Chevedden submitted a shareholder proposal to Apache Corporation, the company pushed back, suing to exclude Chevedden’s latest shareholder proposal and seeking attorneys’ fees if successful. The judge ruled in favor of Apache, finding that Chevedden had not proved stock ownership. SEC rules include requirements for eligibility and content of proposals. “Shareholders should receive qualified legal advice when preparing a proposal,” says Little, “because, if the requirements are not fulfilled, the company can reject the proposal.” The Company Viewpoint “In Overstock.com’s eight year history, we’ve never been joined in a shareholder’s derivative suit,” says Jonathan Johnson, president. “We’ve seen advertisements seeking shareholders to sue us, but it’s never come to anything.” Overstock actively seeks transparency in its relations with shareholders, in hopes of keeping those relationships positive. “We try to be very communicative,” Johnson says. “If my mom wanted to know how this business was doing, I’d talk to shareholders just the way I’d talk to her—very clear and simple and honest.” Overstock hosts a quarterly earnings call, which is open to shareholders, analysts and the public. After earnings are announced, the conference call is scheduled, with a call-in number circulated to invitees and listed on the company website. The call lasts approximately one hour. Company management explains the earnings report, including why the numbers are high or low. A question and answer period is included in the call. “The earnings call is part of our attempt to be candid,” Johnson says. “Shareholders are most upset when bad things happen and they have had no explanation.” Johnson acknowledges that Overstock.com is the only public company he knows which has a plaintiffs’ security class action attorney on its board of directors. Joseph Tabacco, from San Francisco, has been a great help because, as Johnson notes, “we’ve been involved in a lot of litigation.” Although Overstock.com has dodged shareholder’s derivative suits, it has been a plaintiff, itself. “We’re fighting Wall Street. We’ve had a lot of manipulation of our stock through ‘naked short selling’—which is not as exciting as it sounds.” Responding to Shareholder Letters and Calls “When a customer writes or calls, the communication is usually immediately responded to by our CEO,” says Mark Griffin, Overstock’s general counsel. “If more follow-up is needed, he then forwards the question to me, if it’s a legal issue, or to one of the managers, if it’s a business question.” Little, who attends many corporate board meetings as outside legal counsel, also acknowledges that, in his experience, letters from shareholders are taken seriously and discussed at board meetings, if they raise substantial issues. Hiring Experts “Public companies are under a microscope all the time,” says Vic Pollak, Salt Lake City corporate attorney, “but there are experts available to help when a crisis occurs.” Pollak suggests that public companies consider using a skilled PR firm to shape their message to the public and to shareholders when the news is bad, as well as using a proxy solicitation firm to advise on shareholder issues. Pollak also suggests that public companies appoint an investor relations committee of the board to consider such proactive steps as reaching out to the leaders of hostile shareholder groups to see if some settlement can be reached. To Sue or Not to Sue Shareholders derivative suits. Corporate activism. Letters to the CEO or board. Shareholders have several avenues for redress when their companies crash. Speed and a satisfactory outcome are not guaranteed, but all options offer the shareholder ways to seek change and make dissatisfaction known.
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