David vs Goliath

The 2-15-10 court brief from Apache includes the following statement: “When it comes to shareholder proposals, Apache is the ‘David’ and Chevedden is the ‘Goliath.’ ” That seems strange to me coming from a company with a $33 billion market cap. I know John Chevedden and he is no Warren Buffet, when it comes to assets. The last I heard, Apache was represented by multiple attorney’s while Chevedden was representing himself. Yes, David vs Goliath but Apache has it reversed.

This is a case involving basic shareowner rights. At the heart of the slapp suit against Chevedden is Apache’s contention that he must provide evidence that he is the beneficial owner of the appropriate amount of Apache stock to file a resolution. Normally, that wouldn’t be a problem. Every company I have ever filed a resolution with has been fully satisfied with a letter from my broker.

However, my understanding is that Apache has refused to acknowledge the adequacy of evidence provided by Chevedden’s broker and with their further attempt to follow the chain of custody a further level up. Since the shares are held in “street name,” Apache appears to want the letter to come from Cede & Co., which holds the vast majority of corporate stock. Of course, Cede & Co. does not know if Chevedden is a beneficial owner, since their records don’t go that far down.

Have others had a similar demand from Apache or any other company.  Or, if you have a resolution at Apache this year, what evidence of ownership did they require from you or your fund?  Please e-mail me (James McRitchie) if you have any information on these practices.

As I indicated in my earlier post, Apache v Chevedden: SEC Rules Don’t Reflect Reality, part of the problem stems from the language of Rule 14a-8 (b)(2)(i).  “If you are the registered holder of your securities, which means that your name appears in the company’s records as a shareholder, the company can verify your eligibility on its own. Otherwise submit to the company a written statement from the ‘record’ holder of your securities (usually a broker or bank) verifying that, at the time you submitted your proposal, you continuously held the securities for at least one year.”

The SEC rules assume that brokers and banks are “usually” record holders. They are not; at least not technically. Brokers and banks also largely hold “security entitlements,” once transactions are completed. Cede & Co. holds the actual immobilized registered securities. Here’s how attorney Jonas Kron (building from arguments made by Professor Paul Neuhauser in Clear Channel Communications (February 9, 2006)) puts it in a letter to the SEC dated 1/10/2008 regarding a no-action request by McGraw Hill. Although Kron didn’t succeed in this case for other reasons, I understand Neuhauser did.

As is known among securities professionals but not by the typical investor, the ownership structure between the multiple securities intermediaries and beneficial owners is complex. To begin, street name shares are owned by the broker or bank. The broker or bank then deposits the shares in an account at the Depository Trust Corporation. The Depository Trust Corporation, however, is not the record owner.

Rather the shares are held of record by Cede & Co., a nominee of the Depository Trust Company. Therefore, in order to determine the identity of the street name owner one must go first through the depository to the brokers and banks depositing shares, then through the broker or bank to the beneficial owner. This also means that the record owner in the case of brokers and banks is almost invariably Cede & Co, or some other nominee and not the broker or the bank itself. Furthermore, Cede & Co has no knowledge as to the ultimate beneficial ownership of the stock that it holds of record for brokerage firms… Cede & Co. merely knows the gross securities position of each participant in the Depository Trust Company.

Kron also notes this situation is confirmed in footnote 21 of Rel 34-50758A (December 7, 2004) in which the SEC observes:

The relationship between various levels of securities intermediaries and beneficial owners is complex. There may be many layers of beneficial owners (some of which may also be securities intermediaries) with all ultimately holding securities on behalf of a single beneficial owner, who is sometimes referred to as the ultimate beneficial owner. For example, an introducing broker-dealer may hold its customer’s securities in its account at a clearing broker-dealer, that in turn holds the introducing broker-dealer’s securities in an account at DTC. In this context, DTC or its nominee is the registered owner and DTC’s participants (i.e., broker-dealers and banks) are beneficial owners, as are the participants’ customers. However, DTC, the clearing broker-dealer (the DTC participant), and the introducing broker-dealer are all securities intermediaries.

The reality is that the name of the beneficial owner, John Chevedden, will not appear in the company’s, DTC’s or Cede’s records, but only in the records of his broker, Ram Trust. Consequently, his broker is in the best (if not only) position to document who the ultimate beneficial owner is.

SEC Staff Legal Bulletin No. 14B (CF), section C,1, provides guidance to companies on how companies should notify shareowners of defects by providing “adequate detail about what the shareholder proponent must do to remedy the eligibility or procedural defect(s).”

Instead of instructing Chevedden on how to remedy eligibility (or allowing the otherwise universally accepted letter from his broker), Apache seems to have attempted to send Mr. Chevedden on a wild goose chase by implying that he must obtain a letter from the actual holder of record, Cede & Co. As already explained, Cede has no idea who the ultimate beneficial owners are for the stocks they hold. As noted in the Jonas Kron letter to the SEC dated 1/10/2008 quoted extensively above, “Staff has rejected 14a-8f claim when the registrant seemed to demand proof from Cede Co. See Equity Office Properties Trust March 23 2003.”

In a footnote Kron also notes, “See also Clear Channel Communications (February 9, 2006) in which the company also argued that neither the proponent or its broker were record holders. In that case, the proponent made the same argument we are making here leading the Staff conclusion in that case was “that Clear Channel failed to inform the proponent of what would constitute appropriate documentation under rule 14a-8(b) in Clear Channel’s request for additional information from the proponent.”

Also of note, The SEC staff rejected a similar argument made by Dillard Department Stores, Inc. (Mar. 4, 1999). There, the proponent submitted a written statement that the proponent’s shares were held of record by the Amalgamated Bank of New York through its agent, Cede & Co. (“Cede”), the nominee of DTC. Dillard’s argued that the proponent was required to submit a letter from Cede, which Dillard’s argued was the true record owner. The SEC staff disagreed and declined to allow exclusion.

From all the above, it appears that Apache bypassed a “no-action letter” request to the SEC in hopes that Chevedden would be intimidated by a slapp suit that could potentially cost him a small fortune in attorney’s fees if they can convince the federal district court in Texas to rule in their favor. The case should be very simple. Like 99.99% of shareowners holding in “street name” presenting a resolution, Chevedden has met the reasonable requirement that he provide evidence of ownership from his broker.  Only a court dumbfounded by hundreds of pages of largely irrelevant legal argument, or one predisposed to rule in favor of rich and powerful managers, would require a shareowner to document every entity involved in the chain of custody from his broker to Cede & Co. and to get each to sign off on that chain.

Finally, I find it interesting to see how the case is being played out in the limited press coverage it has been given. I posted some thoughts on this early on at Apache Files Slapp Suit: More Support for DRS and Apache v Chevedden: More Comments. I’d now like to point to two examples since then. The first is by a trade publication, Westlaw Business (Proxy Disclosures: Activist’s Last Act in Court?, 2/5/10). It is somewhat obvious from the title that the attention grabber to the largely corporate counsel audience is. Will Apache shut down “John Chevedden’s one man shareholder rights band”?

The author of the article, Erik Krusch, appears somewhat knowledgeable about proxy issues and the idea that most shareowners don’t actually hold registered shares.

Many investors’ shares are held for them by their broker, known as holding a share in “street name”. Under these arrangements, the broker is the record holder and a proponent needs to have introduction letter sent from its broker to the company to which it has made a proposal.

Unfortunately, it is not so simple, as explained above. The broker is not the record holder; Cede & Co. is. Although the article goes on to present some balance, revealing that Apache CEO Steven Farris advised the SEC to abolish non-binding shareholder proposals, it is easy to surmise that Krusch knows who his audience is.

Apache may think Chevedden’s proposal calling for a simple majority vote “already had a lot stacked against it,” but Krusch fails to note such resolutions typically get 70% and 80% support. Again, “Apache decided to try its luck in court and if Chevedden has to foot the legal bills…he might not make quite as many proposals in the future.” Does Krusch think owners of corporations should have to foot legal bills to have issues presented on the proxy?  He doesn’t let us know, so I suppose you could say the reporting is “fair and balanced,” mostly from the view of corporate interests.

The Houston Chronicle is no Mother Jones, but Loren Steffy, their business columnist, seems to have a far better grasp of central issues. His article, When companies know better than shareholders (2/6/10) opens with the following:

I own a few shares of stock, but I’m not sure I can prove it.

I don’t have the certificates. The only proof I have is that my brokerage service tells me I have the shares and tracks the value of my portfolio.

Most shares that investors claim they own are actually held through a chain of custody involving a string of brokers and clearing firms and ultimately residing in a central depository trust.

Technically speaking, none of us actually owns the stock we think we do.

Steffy covers much of the same ground as Krusch but if he is pandering to anyone, it would appear to be the “every” man or woman who is likely to resent “Apache’s legal bullying.” Should management of a $33 billion company prevail against its own shareowner just because they can hire “high-dollar attorneys,” which they have asked the judge to make Chevedden pay for if they win or is this just a case of bullying by managers who want to remain unaccountable to owners? Steffy reveals where he thinks justice lies.

Given the reasonable nature of Chevedden’s proposal — a measure that’s been supported at other companies by far larger investors, including CalPERS, the country’s biggest pension fund — I asked Harrison (Apache’s attorney) why Apache didn’t simply adopt a majority vote on its own.

“Apache believes that its current voting rules are in the best interest of its long-term shareholders and should not be changed,” he said.

In other words, it believes its owners are better served by having less input, and it would prefer they simply shut up and fork over their money.

Then again, based on its legal arguments, Apache doesn’t even seem to believe it has owners.

That’s the real irony here. Apache CEO Steven Farris believes shareowners shouldn’t be able to file nonbinding resolutions… they shouldn’t be able to make formal requests of management. If they do file, only those who hold registered shares will be recognized. Registered shares are usually held by very small investors in DRIP accounts or by employees in 401(k) plans. Of course, the other registered shareowner, Cede & Co. isn’t going to take any action as an owner because their job is simply to hold the immobilized stock.

Given the complicated legal chains involved in “street name” registration and laws that were often written based on a misunderstanding of who really owns corporations, Steven Farris thinks he holds all the cards. Will justice prevail or do court decisions simply depend on who can hire the best attorneys?

This just in: The United State Proxy Exchange (USPX) will be filing a motion for leave to file an Amicus Curiae memorandum with the court later this week. Stay tuned. Also just in, Broc Romanek followed up previous posts at TheCorporateCounsel.net: “As noted by Allen Nelson in the reactions to this case, Chevedden could have easily obtained the evidence showing his record ownership if he had his “tackle” together and made a simple request to DTC. Here is a sample of how he could have proved his ownership and avoided this mess.” The link is to a broker-like letter from Cede & Co., with information concerning the beneficial owner and company redacted.”  The letter includes an attached “Proposal to Declassify the Board of Directors of the Company.” The final paragraph in the letter from Cherl Lambert of Cede & Co. reads as follows:

While Cede & Co., is furnishing this demand as the stockholder of record of the shares, it does so at the request of Participant and only as a nominal party for the true party in interest, the Customers, Cede & Co. has no interest in this matter other than to take those steps which are necessar to ensure that the Customers are not denied their rights as beneficial owner of the Shares, and Cede & Co. assumes no further responsibility in this matter.

Searching the internet, similar letters can be found involving China Yuchai International Limited (NYSE: CYD) here and here.  Another similar letter involving Cryptologic, whose registered office in Guernsey, can be found here.  One common theme is the involvement of companies domiciled outside the United States.

Getting a demand letter from Cede & Co. to inspect the books in order to obtain a list of shareowners of record may be common practice in a bona fide proxy contest. However, it is certainly not common practice when shareowners file resolutions. Nor should it be. How many banks or brokers have been caught lying, by writing a letter evidencing ownership by a customer who is not a beneficial owner?  Even if a rare instance of such behavior can be found, the same could occur if there were a requirement to get broker letters from Cede & Co. Cede doesn’t have a list of beneficial owners. They would have to depend on the word of the bank or broker, just as 99.99% of companies do in accepting a broker letter. Let’s not put up more procedural barriers to the exercise of our rights.

By shifting from street name registration to a system of direct registration, we could all avoid the issues faced by Chevedden. Who owns what would be clear. (see Co-Filers Wanted on Petition to Eliminate Street Name Registration) Neither would we have the problem of blank votes going to management (Support Petition to Keep Blank Votes Blank) or the identity of proxy resolutions being obfuscated on voter information forms (see Investors Against Genocide Fighting American Funds, Broadridge and Vague SEC Requirements: More Problems Solved Using Direct Registration). Additionally, direct registration would put a stop to most of the abuses around firms going dark (Firms Gone Dark: Another Reason to Abolish Street Name). I hope readers will consider joining with us in our efforts to stop these abuses.

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  1. The Harvard Law School Forum on Corporate Governance and Financial Regulation » Who Should Submit Shareowner Proposals? - 03/09/2010

    […] Glyn Holton, Executive Director of the United States Proxy Exchange, wrote the bulk of an amicus curiae brief to help the court better understand how shares are held through a daisy chain of entitlements and how converting rules to “plain English” can lead to apparent ambiguity. I was delighted to help with several sections and think you will find it a compelling read. (see also: Apache vs. Chevedden Takes Dramatic Turn, and David vs Goliath) […]

  2. CorpGov.net » Who Should Submit Shareowner Proposals? - 03/06/2010

    […] Glyn Holton, Executive Director of the United States Proxy Exchange, wrote the bulk of an amicus curiae brief to help the court better understand how shares are held through a daisy chain of entitlements and how converting rules to “plain English” can lead to apparent ambiguity. I was delighted to help with several sections and think you will find it a compelling read. (see also: Apache vs. Chevedden Takes Dramatic Turn, and David vs Goliath) […]

  3. CorpGov.net » USPX to File Amicus Curiae Brief in Apache vs. Chevedden - 02/24/2010

    […] It would be great to see participation by other shareowners assembling supporting arguments in Chevedden’s defense. As noted above, if he loses, we can expect many more shareowners to refuse to accept a simple broker’s letter as evidence of ownership. See previous post on this case at David vs Goliath (updated). […]

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