Omnicom

A lazy, expensive way to intimidate shareholders

March 14, 2014: 9:54 AM ET

A growing number of corporations unhappy with shareholder proposals are taking their frustrations to court.

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FORTUNE -- Who needs polite conversation when you have the American legal system? Corporations unhappy with shareholder proposals are taking their frustrations to federal court, suing investors instead of, you know, working things out with them.

In recent months, corporate law firms have awakened to the prospect of a new revenue stream as companies like Express Scripts and Waste Connections have used the federal courts to sue small investors and prolific proposers -- and have won.

But last week, decisions in two cases could turn the tide. Small shareholders won victories in suits brought by tech firm EMC (EMC) and advertising giant Omnicom (OMC).

The spate of corporations suing their own investors is quite a shift from the past, when lawsuit was considered a dirty word to business people everywhere. In the 1990s and part of the 2000s, lawyers who represented customers, shareholders, or employees with gripes against companies were the bogeymen executives loved to hate. In 1995 and 1997, Joe Nocera wrote in Fortune about silicone breast implant and tobacco settlements in articles with titles like "Fatal Litigation" and "The Plaintiffs Bar Strikes Again." In 2000, George W. Bush slipped into office promising to tame out-of-control lawyers who were, according to the talk of the day, destroying our economy and capitalism by suing companies and reaping large settlements. In 2001, BusinessWeek amplified the attacks on the plaintiff's bar with a cover story titled "The Litigation Machine."

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In the EMC case, which was decided in Massachusetts federal district court, the winning defendants did their own lawyering. Citing a recent Supreme Court ruling, the defendants asked the court to dismiss EMC's lawsuit on the grounds that the federal court did not have jurisdiction since there was no impending threat that the defendants would harm EMC. "Even if EMC could demonstrate that it faced a high probability of an SEC enforcement" if the company decided to exclude the proposal from a vote, such harm would come from the SEC, not the defendants, they argued. Judge Mark Wolf agreed with the defendants, saying there was "no standing and no case or controversy," and even if there were, he would not issue the judgment EMC wanted.

The EMC case involved a proposal to require that the board chair be an independent director. EMC had made some (but not all) of its arguments about the proposal to the SEC before suing its shareholders. The SEC offered an informal view that the shareholder proposal should be included and brought to a vote.

"I regard [bringing the case to court] as an inappropriate practice of depriving the SEC of the opportunity to perform its proper role of considering all the grounds that in this case have been argued to me and giving informed advice," the judge said at a hearing on Friday. Further, he noted, "abetting an end run around the SEC deprives shareholder[s] of a relatively inexpensive opportunity to get claims disputes resolved."

EMC public relations officer Dave Farmer said in a voice message, "EMC is exploring all its options, and beyond that, EMC wouldn't be commenting on the case."

Judge Louis Stanton of the Southern District of New York wrote the following in the Omnicom case: "This case raises the question whether a corporation that has sufficient doubt whether it is entitled to exclude a shareholder's proposal from its proxy materials should consult its attorneys and follow their advice, with the common risk that a court may later hold to the contrary." He noted that "There are thousands of public companies in the United States; they have annual meetings, and their shareholders are free to suggest items for inclusion in their proxy materials." Again, the judge found no "actual or imminent" harm that would give Omnicom's suit standing.

Despite these victories, the corporate rush to federal courts is troubling. Lawsuits take up court time and can be a forceful intimidation tactic.

In 2012, Chevron (CVX) subpoenaed investors' correspondence with the media and others related to shareholder proposals. Chevron chose the "nuclear option," it was like "killing a mosquito with a sledgehammer," says Tim Smith, a senior vice president at Walden Asset Management. "We are in the process of re-filing the three shareholder resolutions from last year. In addition, Walden Asset Management has filed a new resolution citing Chevron's harassment of long-time shareholders," he wrote me in an email.

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If shareholders grow reluctant to submit proposals, companies will be less accountable for their actions. And investors will then have fewer opportunities to bring positive changes to companies, like voting on whether the election of a director should require more than one yes vote (as has been the case at companies like Cablevision and Impax Labs) or if businesses should provide additional information on environmental liabilities.

As it is, shareholders have limited resources. And some companies receive insufficient shareholder focus.. For example, the Comcast-Time Warner merger has attracted plenty of attention, but "investors should be concerned that John Malone is handing additional voting power to CEOs at two companies with significant governance weaknesses," Dana Wise, deputy director at CtW Investment Group, wrote me in an email. "Discovery has had persistent pay for performance misalignment and problematic pay practices for three consecutive years. John C. Malone serves on the boards of six additional publicly traded companies, which is excessive. At Liberty Global, we see a similar misalignment of CEO pay for performance and governance problems. Shareholders should be engaging these companies to address these problems. Granting more power to the CEOs of these companies should be of great concern."

Meanwhile, the corporate shareholder lawsuit train keeps chugging along. The defendants in the EMC case now face a similar suit from Chipotle (CMG) in Colorado federal district court.

Eleanor Bloxham is CEO of The Value Alliance and Corporate Governance Alliance (http://thevaluealliance.com), a board education and advisory firm.

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