ADW Draft 4/24/12

AP edits 5/12/12

Chapter 15 Shareholder Information Rights

Primary Sources Used in This Chapter

DGCL §220

SEC Rule 14a-9

State ex rel. Pillsbury v. Honeywell, Inc.

Saito v. McKesson HBOC, Inc.

Virginia Bankshares, Inc. v. Sandberg

Concepts for this Chapter

  • Inspection rights
  • Procedure
  • Qualified shareholder
  • Expedited court review
  • Proper purpose – shareholder wealth maximization (SWM)

oProper shareholder

  • State law
  • Notice
  • Duty of disclosure
  • Federal law
  • Proxy regulation
  • Proxy antifraud rule
  • Private cause of action
  • Elements: materiality, culpability, causation
  • Remedies (recessionary damages)

Introduction

Question: Why do shareholders need information from the corporation?

Answer: Shareholders need information from the corporation to exercise their right to vote effectively, especially when shareholders attempt to institute corporate reforms. Shareholder information rights facilitate shareholder voting rights, as well liquidity rights and litigation rights.

Question: What kind of information do shareholders need?

Answer: The kind of information that shareholders need may depend on what they need it for. For example, notice of the time and place of shareholders meetings, and disclosure of financial results of operations, are kinds of information that shareholders are entitled to receive. But what about the identities of their fellow shareholders, when shareholders consider engaging in a proxy contest? Or appraisal results valuations when the corporation is considering a merger or acquisition? To what extent are shareholder information rights, effectively, discovery rights prior to litigation? In fact, inspection often used in anticipation of a derivative suit or securities fraud class action given the heightened pleading requirements for both.

A. Shareholder Inspection Rights

Question: Under state laws, what can shareholders inspect?

Answer: Inspection rights were traditionally equitable. Modern state statutes, however, generally allow shareholders to inspect the corporation’s books and records if they have a proper purpose. Federal law requires public corporations to make disclosures in their proxy materials when votes are solicited.

Delaware permits inspection of:

  • The stock ledger
  • The stockholder list
  • Other books and records

DGCL § 220. Inspection of books and records.

(a) As used in this section:

(1) "Stockholder" means a holder of record of stock in a stock corporation, or a person who is the beneficial owner of shares of such stock held either in a voting trust or by a nominee on behalf of such person.

* * *

(b) Any stockholder, in person or by attorney or other agent, shall, upon written demand under oath stating the purpose thereof, have the right during the usual hours for business to inspect for any proper purpose, and to make copies and extracts from:

(1) The corporation's stock ledger, a list of its stockholders, and its other books and records;

* * *

A proper purpose shall mean a purpose reasonably related to such person's interest as a stockholder.

(c) If the corporation, or an officer or agent thereof, refuses to permit an inspection sought by a stockholder or attorney or other agent acting for the stockholder pursuant to subsection (b) of this section or does not reply to the demand within 5 business days after the demand has been made, the stockholder may apply to the Court of Chancery for an order to compel such inspection.

* * *

Where the stockholder seeks to inspect the corporation's books and records, other than its stock ledger or list of stockholders, such stockholder shall first establish that:

(1) Such stockholder is a stockholder;

(2) Such stockholder has complied with this section respecting the form and manner of making demand for inspection of such documents; and

(3) The inspection such stockholder seeks is for a proper purpose.

Where the stockholder seeks to inspect the corporation's stock ledger or list of stockholders . . . the burden of proof shall be upon the corporation to establish that the inspection such stockholder seeks is for an improper purpose.

The MBCA has a similar approach. The MBCA allows for:

  • Ready inspection
  • Articles of incorporation
  • Bylaws
  • Minutes of shareholder meetings
  • Names of directors and officers
  • Inspection with a showing of proper purpose
  • Board minutes
  • Accounting records
  • Shareholder lists

When information is requires a showing of proper purpose, shareholders have to describe the purpose, and the records to be inspected with “reasonable particularity.” The records must be directly connected to the purpose.

Question: Which shareholders have inspection rights?

Answer: Both Delaware law and the MBCA permit inspection by both shareholders of record (whose names appear in the corporation’s stock ledger) and beneficial owners (whose stock is held by another, such as a securities firm). Minimum shareholding percentage or time requirements are no longer common.

  1. Proper Purpose

Question: What is a proper purpose?

Answer: A purpose reasonably related to a person’s interest as a stockholder.

State ex rel. Pillsbury v. Honeywell, Inc. 291 Minn. 322, 191 N.W.2d 406 (1971)

[wrong slide]

Facts: On July 3, 1969 Charles Pillsbury attended a meeting of a group involved in the “Honeywell Project,” which as created to get Honeywell to cease its production of anti-personnel fragmentation bombs being used in the Vietnam War. On July 14, 1969, Pillsbury, who opposed the war, instructed his fiscal agent to purchase 100 shares of Honeywell stock in order to obtain a voice in Honeywell’s affairs so he could persuade Honeywell to cease producing munitions. The agent registered those shares in the name of the family nominee. Pillsbury subsequently bought a single share of Honeywell, which was registered in his own name.

Pillsbury requests the stockholders list from Honeywell so that he can solicit proxies for the election of new directors. Honeywell refuses to provide the list. Pillsbury filed for a writ of mandamus. The trial court ruled for Honeywell, and Pillsbury appealed.

Issue: Did Pillsbury, who bought shares in Honeywell for the purpose of changing its policy of manufacturing war munitions, have a proper purpose germane to his shareholder's interest when he sought to inspect Honeywell’s corporate books and records.

Holding: No inspection allowed. Proper purpose must have a concern with investment and Pillsbury did not have a proper purpose.

Reasoning: Under DGCL § 220 a shareholder must prove a proper purpose to inspect corporate records other than shareholder lists. Although the court will not allow inspection for curiosity, speculation or vexation, it may permit inspection for adverseness to management or desire to gain control of the corporation for economic benefit. The Court is careful about letting things qualify as a “proper purpose,” claiming that “[b]ecause the power to inspect may be the power to destroy, it is important that only those with a bona fide interest in the corporation may enjoy that power.” This means that inspecting shareholder must have the proper standing, and it may mean that courts will not compel inspection by a shareholder holding an insignificant amount of stock.

The court implies that Pillsbury had the wrong reason for seeking inspection. It is concerned with Pillsbury’s lack of investment interest in Honeywell. It notes that he was not concerned with Honeywell, or the short or long term effects of manufacturing bombs, rather Pillsbury was only concerned with his social and political agenda: “Pillsbury had utterly no interest in Honeywell before he learned about its production of fragmentation bombs”

Points for Discussion (p. 416)

1. Shareholder wealth maximization

Question: Would Pillsbury have been more successful if the request had been couched in terms of SWM?

Answer: Maybe. The proposal might have been more successful if couched in economic, rather than social and political, terms. He could have claimed an economic concern about the bomb business. However, the court would require a significant likelihood that the proposal would positively affect value. If the proposal backed up its assertions with credible and substantial connection between the bombs, the company’s reputation, and its profitability or liability, a case could be made. However, there would have to be enough connection to show that the main purpose was corporate value.

2.Purpose of the corporation

Question: If corporations can have purposes other than shareholder wealth maximization, why shouldn’t a shareholder be able to contact other shareholders to install a new board committed to corporate social responsibility?

Answer: Perhaps the reason is that although a corporation has various purposes, the law this court viewed views shareholder value as the driving force behind what is required of corporations. Ultimately, value must be of some importance, otherwise there would be little reason for investors to take a stake in the corporation. Nevertheless, the board and shareholders do have some power to steer the corporation in a direction that fulfills other purposes while still pursuing value for the shareholders.

Saito v. McKesson HBOC, Inc. 806 A.2d 113 (Del. 2002)

Facts: On October 17, 1998, McKesson Corporation entered into a stock-for-stock merger agreement with HBO & Company (“HBOC”).” Several days later, Saito purchased McKesson stock. The merger was completed in January 1999 and the combined company was renamed McKesson HBOC, Incorporated. Between April and July 1999, McKesson HBOC announced a series of financial restatements triggered by its year-end audit process. Apparently, the restatements were needed because of HBOC accounting irregularities. The company then decreased their revenues by $327.4 million for the three preceding fiscal years.

These announcements caused several lawsuits, including a derivative action (Ash v. McCall). Saito was one of four plaintiffs in the derivative action that alleged (1) the directors breached their fiduciary duties by failing to discover accounting irregularities before the merger, (2) corporate waste by entering into the merger, (3) breach of duty by failing to monitor compliance with financial reporting requirements prior to the merger, and (4) failure in the same respect following the merger.

Saito sought information under DGCL Sec. 220.

The Court of Chancery dismissed the action and instructed the Plaintiffs to “use the tools at hand” to obtain the requisite information to sue derivatively. Saito was the only person that followed the Court’s advice and demanded access to eleven categories of documents. Some of the documents that he requested related to information prior to his acquisition of the stock. The Court of Chancery held that “Saito stated a proper purpose for the inspection of books and records – to ferret out possible wrongdoing in connection with the merger of HBOC and McKesson. But . . . the proper purpose only extended to potential wrongdoing after the date on which Saito acquired his McKesson stock.” The Court of Chancery also held that “Saito was not entitled to documents relating to possible wrongdoing by the financial advisors to the merging companies.” Saito appealed.

Issue: What are the limitations on a stockholder’s statutory right to inspect corporate books and records?

Holding: A stockholder who demands inspection for a proper purpose should be given access to all of the documents in the corporation’s possession, custody or control, that are necessary to satisfy that proper purpose. The scope of inspection is limited however “to those books and records that are necessary and essential to accomplish the stated, proper purpose."

Reasoning: Like the Court of Chancery, the Delaware Supreme Court engaged in a demand-by-demand review of the different categories of documents that Saito had sought to inspect:

Standing Limitation

The Court of Chancery held that Saito was limited to examining those documents that followed the announcement of the merger since “[b]y statute, stockholders who bring derivative suits must allege that they were stockholders of the corporation ‘at the time of the transaction of which such stockholder complains.’”

The Delaware Supreme Court disagreed, stating, “[e]ven where a stockholder’s only purpose is to gather information for a derivative suit, the date of his or her stock purchase should not be used as an automatic “cut-off” date in a §220 action. The Supreme Court attributed this to the fact that

(1) the potential derivative claim may involve a continuing wrong that both predates and postdates the stockholder’s purchase date, and

(2) the alleged post-purchase date wrongs may have their foundation in events that transpired earlier. Therefore, the Supreme Court concluded, “the date on which a stockholder first acquired the corporation’s stock does not control the scope of records available under §220.”

“If activities that occurred before the purchase date are ‘reasonably related’ to the stockholder’s interest as a stockholder, then the stockholder should be given access to records necessary to an understanding of those activities.”

The Financial Advisors’ Documents

The Court of Chancery held that Saito did not have a proper purpose to inspect documents relating to potential claims against third party advisors who counseled the boards in connection with the merger.

The Delaware Supreme Court disagreed, stating. “[t]he source of the documents and the manner in which they were obtained by the corporation have little or no bearing on a stockholder’s inspection rights.” “The issue is whether the documents are necessary and essential to satisfy the stockholder’s proper purpose.” Here, Saito wants to investigate possible wrongdoings relating to McKesson and McKesson HBOC’s failure to discover HBOC’s accounting irregularities. “Since McKesson and McKesson HBOC relied on financial and accounting advisors to evaluate HBOC’s financial condition and reporting, those advisors’ reports and correspondence would be critical to Saito’s investigation.”

HBOC Documents

The Court of Chancery held that Saito was not entitled to any HBOC documents because he was not a stockholder of HBOC before or after the merger (Saito was a stockholder of HBOC’s parent, McKesson HBOC).

The Delaware Supreme Court agreed with the principle used by the Court of Chancery, but disagreed with its application to the facts. Absent a showing of a fraud or that a subsidiary is in fact the mere alter ego of the parent, stockholders of a parent corporation are not entitled to inspect a subsidiary’s books and records. The Supreme Court found that the rule applied to the HBOC books and records that were never provided to McKesson or to McKesson HBOC, but not to the relevant documents that HBOC gave to McKesson before the merger or McKesson HBOC after the merger. The Supreme Court stated, “[a]s with the third party advisors’ documents, Saito would need access to relevant HBOC documents in order to understand what his company’s directors knew and why they failed to recognize HBOC’s accounting irregularities.”

Points for Discussion (p. 422)

1. “Proper purpose”

Question: Is there a unifying thread to the Delaware requirements for showing a proper purpose? Does the Delaware court address the question of whether a shareholder could seek documents about the company’s social or political activities? Does the Delaware allocation of the burden of proof make sense?

Answer: Shareholders should be able to protect their ownership interests by inquiring about activities related to that interest. This resembles limitations on the discovery process in litigation. We want parties to have some degree of access to information that can help them assess their claims and later prove the case. However, there are various ways that the law limits that access. First, a plaintiff must have a proper purpose to get access to discovery; in civil litigation, a feasible claim that could be shown with evidence meets that test. Next, the access by both parties to information requires the possibility that it has some relevance to the dispute; while this is sometimes a liberal interpretation of relevance, there are limits to the information that can be sought. Likewise, to exercise inspection rights shareholders must show that they have an interest that is potentially being violated, and then the corporation is obligated only to produce information related to the shareholder’s primary purpose. If the political or social activities were substantial enough that the information sought could show their legitimate effect on the shareholder’s interest, the shareholder would satisfy the “proper purpose” test.

2. Nature of judicial review

Question: Why not make inspection, and the review of the documents being sought by the shareholder, part of the litigation process?

Answer:Without some pre-litigation access to information, the shareholder will be powerless to survive a motion to dismiss – the shareholder will not be able to allege any claim because it will not yet know what claims it could pursue. In typical litigation, the claimant has at least some basis to establish the claim before going into discovery. Delaware courts have to balance allowing the shareholder to have some access to information and giving so much access that the corporation (and the shareholder’s interest as well) will be harmed.

3. Fishing expedition

Question: How can shareholders get pre-inspection information?

Answer:Pre-inspection information may come from public filings, annual reports, public statements by the corporation, and other publicly available sources that may suggest possible wrongdoing. The standards for this may be lower than the pleading standards for a proper complaint, but should still prevent shareholders with unmerited meritless claims from getting access to information.

4. Confidentiality conditions

Question: How can information obtained in an inspection be kept confidential?

Answer: Delaware courts have wide discretion in prescribing inspection conditions. Confidentiality conditions are part of the landscape of litigating in Delaware.

5. Publicly available information

Question: Should a shareholder be able to seek inspection of information or documents that are publicly available, or for which summaries are publicly available?

Answer: There might be a situation in which publicly available documents are based on opinion letters or other underlying documents, and it is only the underlying documents that actually provide a shareholder the basis for a lawsuit. But it seems fair for the courts to require that shareholders look to public information first. If there is a conceivable way that information could establish a claim, however, the court may allow inspection of the underlying documents.