Shareholder rights…did you know you have them?

"It is a notorious fact, however, that the typical American stockholder is the most docile and apathetic animal in captivity.  He does what the board of directors tell him to do and rarely thinks of asserting his individual rights as owner of the business and employer of its paid officers.  The result is that the effective control of many, perhaps most, large American corporations is exercised not by those who together own a majority of the stock but by a small group known as 'the management.'" Graham, Benjamin. Security Analysis 1941.

Americans are raised with a strong sense of rights; starting with the inalienable rights of life, liberty and the pursuit of happiness.  These rights extend from the Declaration of Independence to the Constitution and beyond through codified laws.  Americans are quick to proclaim loudly when their rights are infringed upon.  It doesn't matter if these rights are true rights, or presumed rights not backed by law, Americans feel strongly about rights!

There is a strange disconnect between citizenship rights and shareholder rights, a disconnect I don't fully understand.  As a citizen we have rights granted to us by a government, rights that are very hard if not impossible to change.  Citizens only get one vote, and the only way to affect change is to petition an elected official or become one, and even then change is slow.  The same can't be said about corporations.  A shareholder can buy more votes by buying more shares, and if they own enough shares can fire management or take over the company driving change themselves.

Benjamin Graham's quote from the 1940s still rings true today.  Most shareholders are docile, most fail to vote proxies and those who do vote often side with management.  Shareholders with small positions on mega-cap companies might view their votes as futile, even still, why throw away something you purchased?  The types of companies I typically invest in are smaller, some very small where a significant position can be built quickly, and shareholder votes meaningful.

I recently finished a book The White Sharks of Wall Street, which I highly recommend.  The book details the history of a group of modern corporate raiders who began taking over companies in the 1930s up through the 1960s.  These men, including Thomas Mellon Evans, invented many of the modern takeover techniques we know about today, yet their stories have been lost to the sands of time.  Tom Evans was known as a liquidator, he bought companies for less than NCAV or book value and liquidating divisions for a gain.  The author is a financial journalist for the New York Times, which means what could have been dry material reads quickly and is fascinating.  This isn't a textbook, but rather an informative history.  It's worth noting that Tom Evans apparently ran in some of the same circles as Benjamin Graham.

In the spirit of the book I wanted to discuss a number of rights shareholders have that they might not know about.  The rights I'm detailing below are for shareholders of Delaware corporations, which most public companies are.  Companies are governed by the state they incorporate in, and the state they reside in.  Some states have different rules and regulations, with some like Nevada being notoriously shareholder unfriendly, whereas Delaware is very shareholder friendly.  If you plan on undertaking any action against a company you own please find the relevant state first, small nuances can lead to significant differences.

I am not a lawyer which is probably evident by my readable writing, but I wanted to state it anyways.  I have read the Delaware corporate law along with the corporation law for a few other states, they were available free online.  If any of this is wrong please make a note in the comments and I'll edit the post.

Shareholder vote - By law shareholders are entitled to one vote per share unless stated otherwise for a specific series of shares.  This might seem like the simplest of all the rights, yet it's the most powerful.  Shareholders are not restricted to one vote per person as in a governmental election, shareholders can purchase as many votes as they want by acquiring shares.

Companies are required to put directors up for election every so often as determined by the company's bylaws.  When directors are up for re-election the shareholders have the responsibility of evaluating their qualifications and voting, or not voting them in.  If a director isn't qualified shareholders can vote that director out and propose their own director.

Some companies have cumulative voting which is extremely powerful, one holding of mine has cumulative voting.  An example is the best way to explain what cumulative voting is.  Take a director election with five directors up for re-election, a shareholder with one share has five votes, one for each director.  The shareholder can vote yes or no on each individual director, but they get one vote per director.  In a cumulative election that shareholder can take those five votes and direct them all at one director or nominee.  This is important when a minority shareholder has enough votes cumulatively to get a seat, but not enough votes overall to secure a seat on the board.

Annual meeting -  Delaware companies are required to hold a meeting annually.  Not all companies comply, and there isn't anyone policing compliance besides shareholders.  If a company fails to hold an annual meeting a shareholder can go to the Delaware court to compel one.  Case law is very clear on this issue, if a company has failed to hold a meeting the court will compel it almost without question.

An interesting side-note to this section of the law is that Delaware law also requires companies to prepare a list of shareholders who are allowed to vote during the meeting.  The company is supposed to have this list available at the meeting and allow shareholders to view it and copy it if they desire.

Appraisal rights - If a company becomes party to a merger or take over shareholders can obtain what are called appraisal rights.  Appraisal rights give the shareholder the ability to contest the value offered as consideration in the transaction.

For example Company A comes along and offers Company B shareholders $10 per share to acquire the company.  If Company B has $5 per share in earnings shareholders might feel like the price offered isn't fair and exercise their appraisal rights.

When a shareholder exercises these rights their shares become frozen and they are not allowed to vote for or against the corporate action.  If the shareholder votes for or against the action in most cases they invalidate this right.  Filing for appraisal rights needs to happen after the action is announced, but before any vote takes place.

The rights are a bit odd, it's possible a shareholder could exercise them and win with the court saying the shares are indeed undervalued.  The company might then be forced to pay the exercising shareholder a higher consideration.  What's strange is that all of the other shareholders who didn't exercise this right receive the initial consideration they agreed to, even if the court rules they were offered an unfair deal.

Worth noting is a history of long drawn out court battles over appraisal value.  Long court battles mean high lawyer costs, which the shareholder is responsible for alone.  Also worth considering is the valuation methodology that the state uses.  If the state uses DCF and the company is fairly valued on a DCF basis it doesn't matter that they're selling for 1/3 of net cash, the shareholder will lose in court.

Right to inspect books and records - A shareholder is the legal owner of a corporation, just like a homeowner is the legal owner of their home.  Likewise it isn't strange if a homeowner were to walk through their home looking at what they own, yet in the corporate world owners are treated like outsiders on their own property.

As a legal owner a shareholder is granted through law the ability to inspect the company's books and records.  For SEC filing companies this isn't an issue, companies disclosure anything an investor might want to inspect to all shareholders through EDGAR.  For non-filing companies, and private companies things are different.  Shareholders have the legal right to see a company's financials no matter what the CFO says.  I've talked to companies where the CFO flat out lies and claims shareholders don't have this right which is a shame.

The Delaware courts look favorably upon shareholder record inspection requests if a valid reason is given, and if the company hasn't made information available.  The requestor is responsible for paying the costs associated with obtaining this material and at times traveling to the company's headquarters or Delaware to inspect the records.

In addition to inspecting a company's books shareholders also have the right to examine and make copies of the shareholder register.  This is the list of who owns the shares, and how many shares they own.

A company by law has five days to respond to a records request, if they don't respond within five days the shareholder has the right to petition the court to view the records.

How to use?

This is probably the trickiest part of the post.  For all actions besides voting on a company issued proxy action needs to be taken on the part of the shareholder.  A complicating factor is that most shareholders are not in the shareholder register because they hold their shares in street name (at a broker).  If you wish to exercise any of the above rights and you hold your shares in certificate form you won't have any issues, proof of ownership and a letter to the company with your intentions is a good starting point. Some rights, such as a records request have specific requirements such that the request be provided in writing and the requestor sign under oath.

If you are a shareholder in book entry form and wish to undertake any of the above actions cooperation on the part of your broker is required.  The Delaware court does recognize beneficial holders as legal owners, but a letter from the brokerage verifying ownership is required.

Talk to Nate about shareholder rights

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  1. I feel like it's easier, safer, and more profitable to deal with ethical management teams. (Unless you're a corporate raider who is able to kick everyone else out.)

    The unethical management teams are more likely to commit fraud and/or run off with lots of company's money. Even if you were to have management kicked out, you may not "win" in the end.

    1. Thanks for the comment. I agree that ethical management teams are best for the long haul, although if the discount is steep enough, and there are enough protections in place saddling up with a less than perfect management team might be acceptable.

      I'm not worried about fraud with these little companies, I'm mostly worried about self dealing. Companies with $2m market caps where the CEO is making $1.5m is the biggest problem. Where executives are essentially stealing profits from shareholders.

  2. Another example of a topic completely ignored in undergraduate b-school. So shameful.

    Do you have any insights on engaging management teams? That seems to be another shareholder priveledge under-taught.

    1. My best advice is to just give them a call. When I've called many of these tiny companies I first get the receptionist, I then ask for the CFO or CEO, and either their on a call or I end up talking to them.

      Some of these people are nice to shareholders, others are rough, which is ironic because in some cases I own more of the company than they do…

      Just pick up the phone and call. If you want a specific question answered email usually works as well. I've been pretty successful at guessing email addresses for executives.

  3. Great stuff Nate.

    Something worth noting on the appraisal rights is that Delaware typically will nullify certain discounts (Minority discount non-majority holders and Market Discounts for thinly traded stocks) putting the minority shareholder on equal footing (somewhat at least) with a majority owner.

    However, Ohio (and I am sure a few other states) typically does allow these discounts. Your profile of Randall Bearing (RBRG) indicated they did (or were in the process of) changing their state of incorporation to Ohio. The minority shareholder can expect to get pushed around should management try to take the company private.

    Probably backed to GlennChan's point.... lie with the dog and you will get the fleas. Choose your partners wisely.

    1. Thanks for the comment, really interesting information.

      On Randall, yes they chose Ohio because Ohio's takeover laws favor management. A reader actually pursued Randall a bit and was able to obtain the shareholder register, not surprisingly the majority shareholder is the CEO and their largest supplier. These two own a majority unfortunately.

      I know Indiana is rough for shareholders as well as Nevada. Florida seems surprisingly shareholder friendly except for a takeover provision where if a shareholder acquires more than 15% their shares lose all their votes unless the BOD reinstates them.

      I agree that unless one has the capital to undertake a takeover, or the discount is large enough ethical management should be desired.

  4. This was news to me, but did you know that the ridiculous Ohio takeover laws stemmed from the hostile attempt by Sir James Goldsmith for Goodyear back in 1986?

    So what started out as "well-intentioned" (1) lawmakers trying to protect Akron, Ohio jobs from being outsourced has, over the years, been transformed into a sort of "forum shopping" for furthering management entrenchment / minority shareholder abuse.

    Ahhh... you just gotta love it, right?

    Anyways, I completely stumbled upon this as I was reading about the history behind Lancaster Colony. Btw, is it just me or does it seem like these conglomerates (Danaher is the other one that immediately comes to mind) are getting back en vogue for no apparent reason? Seems intimately connected to this alluring idea of riding "jockey-plays."

    (1) Well, for the Goodyear employees anyways.

  5. Where might I look to discover when a person becomes a shareholder of a DE corporation? Is it at point of sale/transfer/conversion or does the company/shareholder have to observe certain formalities/consents beforehand? Thanks.