3.2.3 Who are the shareholders?

Although on paper in corporate law shareholders do not have much power in the US, shareholders have and are obtaining more and more leverage through activists and combining their power and by enlisting the media.1

Whereas share ownership was very fragmented until the 1980s, it has now become slightly more concentrated. In 2001 more than 50% of the shares of US public companies have been owned by investment institutions. This is a smaller percentage than in the UK, and each of the institutions owns a smaller percentage than is normal in the UK. A dialogue between boards and shareholders has always been less frequent and open in the US than in the UK.

Although all shareholders of the same class are equal according to the strictly legal definition of their rights,2 in the 1980s financial markets showed a complex web of relationships between corporations and varying types of institutional investors. In some cases real economie and political power is exerted by such institutions. When they act in groups, the pressure can be overbearing.

In practice, it can no longer be assumed that all shareholders are equal. Shareholders should be classified according to their investment objectives along a spectrum, with investors at one end and traders at the other. In this way, managers of corporations will come to realize the concept of "shareholder value" is not sufficient if the different types of shareholders are lelt out of the equation. Not all shareholders have the same motives.3

There are various levels of shareholder participation:

This is comparable to the findings for the UK of Tomorrow's Company, described in sub-section 2.5.10 above.

Different shareholders have different aims and goals. For example, level 3 and 4 shareholders may want higher dividends, whereas level 1 and 2 shareholders may want profits to be ploughed back into R&D.7 Two myths exist about investment behaviour in the US: first, that institutional investors buy and sell stock for the short-term, and second, that business corporations carry out their business only to please short-term investors. Generally speaking, these myths are unfounded: first, level 1 and 2 investors, as described above, invest for the long-term;8 second, many business corporations develop strategies for the long-term.9 Many active investor-oriented shareholders are mindful of stakeholder interests.10 Cultural and legal resistance against banks, insurers and mutual funds holding and voting large blocks of shares has not yet been overcome. Most corporate pension funds are not active in corporate governance issues of the companies in which they hold shares. By contrast, public pension funds have been more active. For example, CalPERS and others11 have prodded boards to set up governance and review procedures.12

Shareholder activism by large US public pension funds has traditionally been pursued only by means of shareholder proposals and direct engagement and negotiations with senior managers rather than by outright proxy contests. This is because trustees and asset managers of such pension funds are subject to stringent fiduciary duties.13 Their stake in a company remains limited and there is no economie justification for the costs of an activism campaign. Usually large public pension funds first adopt and update corporate governance guidelines and promote adherence to them. In this process, pension funds tend to rely on support from influential proxy advisors (such as Risk Metrics, now Institutional Shareholder Services (ISS)) and shareowner associations (including the Council of Institutional Investors (CII)) and International Corporate Governance Network (ICGN)). Mutual funds and other institutional investors are often solicited to give support by voting in line.

However, some hedge funds regard shareholder activism as a real investment strategy. They tend to acquire larger interests in fewer corporations and demand changes regarding a wide variety of issues (from governance improvements to financial corrections and even fundamental strategie changes). They can discretely engage with management and corporate boards, but are sometimes prepared to become hostile (e.g. going public with the debate, launching a proxy contest or making a takeover bid). Having incurred the costs and removed the obstacles to their governance wishes, they then ask others to tag along, vote in line with the hedge fund and benefit from the change without the expenditure. To this end, hedge funds can rely on new SEC tules permitting solicitation of the votes of up to 10 additional shareholders without filing proxy materials.14

In the US good communication between boards and major shareholders is considered important. The most recent developments show that activist shareholders often rely on their ability to obtain support from fellow — more passive investors. For the board, establishing a continuous dialogue with these large investors usually serves the purpose of making the views of management and board filter through to those more passive investors.15

The main point from the board's point of view of having good communication with institutional shareholders is to obtain backing for the board's strategy. This clearly happened in 1995 when the board of Chrysler and its CEO Robert Eaton successfully defended itself against a hostile takeover by Kirk Kerkorian, who was backed by former Chrysler CEO Lee A. Iacocca. The Council of Institutional Investors, representing nearly 100 public and private corporate pension funds, supported the Chrysler board.16

To quote Robert Eaton:

In 1992 the SEC changed its proxy rules to make it easier for shareholders to communicate with each other.17 The rise of shareholder activism in recent decades, since 1992 and especially since 2002, has increased the importance of communication between board members and shareholders. Today more than ever, the business community recognizes the need to restore investor confidence and the credibility of capital markets. In this environment, activist shareholders can act as catalysts for change by creating a triggering event (e.g. a revision of capital structure, a strategie decision such as the sale of non-core business lines, a new incentive-based compensation scheme, or a cash distribution) that will unlock shareholder value and yield investment return. The SEC contributed to this trend by relaxing the rules in 2003 and 2010.

Many aspects of communication in the US by management and boards with major shareholders and shareholder activists hold useful lessons for Dutch practice.

However, communication is still less easy for US shareholders than for their British counterparts because the Regulation Fair Disclosure under the Securities Exchange Act of 1934 prohibits the selective disclosure of material non-public information — Regulation FD18 — which, however, is recently being interpreted in a more friendly way, as described hereunder.

In the US one-on-one meetings of directors with individual shareholders are regarded as useful for directors' long-term strategy but the legal pitfalls are substantial.

The general legal concerns are (1) prohibition of misleading statements or omissions.19 Any misleading has to be material which means any fact, projection or estimate that would alter the full information for a reasonable investor and omission means failure to correct or update statements in mandatory filings such as annual and quarterly reports. Insiders must disclose or abstain from trading and all material information must be made public, once given to anyone, which means that if certain information is given to an analyst or investor during a meeting it is very dangerous to give different information in another smaller group.20 (2) Selective, i.e. material non-public disclosure is not permitted, especially when it is given to broker dealers, investment advisors, investment companies and any kolder of shares, with the exemption of "temporary advisors", who owe trust and confidence to the issuer, or those who expressly agree to confidentiality, of credit rating agencies, for the purpose of public rating and/or "road shows" and (3) special care is required concerning earnings and earning estimates, Mergers and Acquisitions and Joint Ventures, changes in assets, new discoveries, acquisition or loss of contracts, changes in control in management, change in management stock splits, dividends, defaults, bankruptcies. If such information is given selectively it must simultaneously be made public by Form 8-K.21 In the US it is normal not to announce anything about pending negotiations until a deal is final.

The general advice of US lawyers to whoever enters this minefield is to (1) be consistent, (2) centralise the response in one person, (3) keep a log, (4) prepare questions and answers, (5) do not give selective disclosure of material information, (6) be ready to make public disclosures, (7) respond to rumours, (8) have periodic, quarterly calls with analysts, (9) plan them by requesting questions in advance, avoid forward-looking financial information, avoid commenting on analysts' estimates, avoid giving any information in "black-out" periods and realize that speaking at industry conferences is non-public.

From the above summary, one might get the impression that there are so many "doubts" that it were better not to see or communicate with any shareholders, except at AGM's or through the public media. To counter this impression the SEC has recently issued a Question and Answer: Does Regulation FD prohibit directors from speaking privately with a shareholder or a group of shareholders? The answer is: No. Regulation FD prohibits selective disclosure of material non-public information to a shareholder in circumstances where it is foreseeable that the shareholder will purchase or sell securities based on that information. The company should implement procedures to avoid Regulation FD violations, such as pre-clearing discussion topics with the shareholder or having company counsel participate in the meeting. Of course if the shareholder enters into a confidentiality agreement there is no problem.22 In the Netherlands the Autoriteit Financiële Markten (AFM) has also issued a comparable Question and Answer notice.

Generally, the non-CEO chairmen rarely talk with shareholders alone. If they meet shareholders, they usually do so with an executive or at least the general council. One of the reasons is that executives know more of the facts and know better what is insider knowledge and what is not.

In recent years private US groups have won many rights for shareholders, not only in practice but also in law.23 These have included proxy access, say-onpay, voting by brokers and a separate non-CEO chairman. The Dodd-Frank Act of 2010 has represented a breakthrough on all these points.

As mentioned above, the best protection for companies against shareholder activists is steering good and detailed communication with major shareholders, which is possible and important and should be done with care. Selective distribution of material non-public information is prohibited if it is foreseeable that the shareholder will trade in shares based on that information.