As a lawyer, I take a certain level of interest and amusement out of the use of little-referenced laws or legal maneuvering to accomplish a task. In the case filed by hedge fund star David Einhorn against Apple (NASDAQ:AAPL) last week in the New York U.S. District Court, just such an approach is the basis for the lawsuit. While the purpose of the suit is to block the Feb. 27 vote by shareholders on a proposal that would alter how preferred shares can be issued, the complaint alleges that the company has violated an Securities Exchange Commission rule that prohibits "bundling" of unrelated matters into a single vote.
It remains unclear what ramifications a victory by Einhorn would actually have on the company or the stock, but the definite result is that the central issue has been brought squarely into the light. As the case unfolds ahead of Apple's annual shareholders meeting, focusing on any reactions from Cupertino may give you some insight into how the case will be handled and what moves Apple may make as a result. Ultimately, all the theatrics are a testament to how strongly positioned the company really is.
Under Section 14 of the Securities Exchange Act of 1934 (link opens PDF), a company is not permitted to "bundle" multiple issues together into a single issue. The theory behind the law and the SEC rules that support it is that the company should not be permitted to provide a sweetener that might incline certain shareholders to vote in favor of a decision that they would otherwise be opposed to alone. To take an absurdly oversimplified hypothetical, consider the following fabricated example: "XYZ Corporation would like to issue a special dividend to pay every shareholder $2.00 per share and also grant every member of upper management any additional 100,000 dilutive shares; vote yes or no." Shareholders must be given the chance to approve the special dividend and reject the share issuance.
A recent report by Reuters cited one of the few related precedents from the 2nd U.S. Circuit Court of Appeals which "recognized an implied private right of action by shareholders suing over alleged anti-bundling rule violations." While the precedent backs Einhorn's positions, other legal experts have noted that Apple may choose to argue that since all of the elements of the proposal deal with amendments to the Articles of Incorporation, they are, in fact, sufficiently related to be grouped together. This argument is a stretch, particularly when amendments to the Articles are in play, as they go to the very nature of how the company may conduct business.
Taking the other side of the argument is ISS Proxy Advisor Services: "ISS policy supports the elimination of 'blank check' preferred shares, because of their potential to be misused in a takeover defense." The preferred shares in question may be issued by the board of directors without shareholder approval and are most commonly used to fight off a hostile takeover. As Einhorm points out, however, the notion of an Apple takeover is thoroughly absurd.
In further commentary on the situation, ISS said it "generally believes bundling of proposals is not in the best interest of shareholders." This is a deeply impressive position for an influential advisor to take given the fact that bundling is de facto against the law. There is, in fact, a basis for the rule, which ISS has succinctly stated, which is that bundling is contrary to shareholder interests in most cases.
Does it really matter?
In response to the lawsuit, Apple issued a press release in which it stated: "Currently, Apple's articles of incorporation provide for the issuance of 'blank check' preferred stock by the Board of Directors without shareholder approval. If Proposal [No.] 2 is adopted, our shareholders would have the right to approve the issuance of preferred stock." The company claims that the measure is designed to enhance corporate governance and protect shareholders. While it seems counterintuitive to think that requiring shareholder approval is bad, Einhorn contends that it creates an unnecessary impediment to issuing the preferred shares that would "unlock the value on Apple's balance sheet."
The issue that seems to be overlooked is that if Einhorn is successful, it may delay the vote, but will not necessarily change anything. If the court finds the bundling to be improper, Apple may simply choose to unbundle the issues and press forward. A reading of Proposal No. 2 does not suggest that shareholders would necessarily vote differently if the preferred stock issue were considered in a vacuum.
What the lawsuit has done is draw significant attention to the fact that Apple is sitting on roughly $137 billion in cash. This alone may be sufficient to get the company to figure out a way to return money to investors in one way or another. The takeaway when you look beyond the legal wrangling is that Apple is in great shape, and at the bottom of a 35% sell-off, the stock is a buy.