Robert Adamson, Executive Director
Centre for Corporate Governance and Risk Management
The hedge fund Mason Capital (US) and Canadian Telus Corporation crossed swords this year when the Telus Board of Directors’ tried to consolidate voting and non-voting class shares (which was anticipated and authorized in the corporate articles). These issues may seem technical but go to the heart of principled corporate governance. This legal battle was not only about share consolidation and equity of shareholder rights to vote and call meetings, but also about whether short-term investors with little or no long-term economic interest in a company should be able to use their shareholder position to direct or vote against decisions that boards and management have decided are in the company’s best interest.
This is not an easy issue for courts to decide. The facts of the case are somewhat complicated and they pit issues of shareholder rights and democracy against the rights of boards and management to make long-term decisions for the company. But understanding the facts is important to understanding what may be at stake in this case and many others that never make it to the public eye, let alone to court.
Though Mason Capital held almost 20% of Telus shares, it has also sold short or bet against Telus shares as part of a complex arbitrage and hedging investment strategy. Mason Capital only became interested in Telus as an investment opportunity after Telus announced that it wanted to consolidate its voting and non-voting shares on a one-to-one basis.
The reasons for Telus undertaking this share consolidation reflect both general corporate governance objectives to create universal shares for marketplace liquidity, and more specific Canadian regulations around foreign ownership which led to separating voting and economic interests. More particularly, significant trends in reducing the foreign ownership of Telus stock meant it no longer required dual class shares.
When Telus announced that it was consolidating its dual class shares, Mason Capital invested as part of an arbitrage strategy that exploited the difference in price between voting and non-voting shares. Mason Capital invested in voting-class shares and, at the same time, shorted both voting and non-voting class shares. If the consolidation plan failed, Mason Capital would benefit if the historical spread between voting and non-voting class shares reemerged. But even if the Telus consolidation plan succeeded, the arbitrage and hedging strategy would mean that Mason Capital would not lose on its overall investment.
It is no surprise that Mason Capital opposed Telus’ share consolidation plan. Mason Capital wanted holders of voting shares to continue to receive a premium as part of any share consolidation since this would help derive maximum benefit from Mason Capital’s arbitrage strategy. To promote its interests as a shareholder, Mason Capital wanted to call a meeting for shareholders of voting class shares, which trade at a premium, to get backing for its plan for a continued separate classes. To facilitate its plan, Mason Capital hired securities depository services (CDS Clearing and Depository Services Inc.) to make the requisition on its behalf (and allowing Mason Capital to remain anonymous in the process). Mason Capitals’ request as made by CDS was refused by Telus and denied through a decision of the Supreme Court of BC.
The BC Supreme Court decision in August was appealed and recently overturned on some matters by the BC Court of Appeal . Even more recently Telus shareholders voted on October 17 to proceed with the share consolidation plan which appears to settle the question for them, but the issues raised and lessons learned deserve note.
One concept which is attracting more attention and which was considered in the recent courts decisions is that of empty voting. Mason Capital’s shareholdings represented 18.73% of Telus’ voting shares but due to the preponderance of non-voting shares that represented a net investment of only 0.02% of Telus’s share capital (Prof. Anita Anand, FP Comment 17Oct12). One expert referred to this as “…a 1000-fold multiple of net economic interest, leveraging Mason Capital’s voting rights to “empty voting” shares of non-voting equity in Telus. (Anand 17Oct12 re: H. Hu affidavit).
The case is, therefore, of interest to us also as an example of several challenges of the equity and marketplace credibility north and south of the Canada-US border of multiple-vote, and non-voting shares – practices which have become common in the past generation (since 1990) and which are increasingly coming under scrutiny for unintended consequences.
Even though this arbitrage and hedging strategy creates little or no economic interest in Telus, and the trial court implied a concern that the interests of an empty voter and other shareholders are no longer aligned, the BC Court of Appeal decided that there are no corporate laws that preclude Mason Capital from requisitioning a meeting a shareholders to consider its proposals so long as the requirements of the governing legislation (BC Business Corporations Act ) are met. The Court indicated that it is for regulators and policy makers to create laws to prevent this conduct which, the court agreed, at least raises concerns.
But should there be new laws or regulations to prevent the type of conduct that Mason Capital has pursued? If “empty voting” is a strategy that interferes with a company’s ability to make good governance decisions in the best long-term interests of the company, (eg (15 Oct12) www.theglobeandmail.com › Report on Business › Streetwise) should regulators and policy makers act to at least provide rights of disclosure or review? At present, the extent of empty voting in Canada is unclear (note, however, recent examples in WIC, CHUM, Oshawa Foods, Magna International). Yet the disclosure rules around these types of transactions and the complex hedging and arbitrage strategies of short-term investors, make it nearly impossible to know the nature and extent of empty voting.
So this case is not only about some technical and mundane share consolidation plan. It raises complicated issues about corporate governance, the rights of shareholders, and an increasingly important concept of empty voting. Mason Capital argued that shareholders paid more for voting class shares and that any share consolidation plans must reflect that premium. It does seem reasonable to expect that shareholder interests should not be diluted unfairly, and the Mason Capital conversion proposal of roughly 1.05 voting to non-voting based on market spread sounded reasonable to some. On the other hand, Telus argued that it is attempting in its share consolidation plan to implement universal voting rights where there are no distinctions of rights or attributes between voting and non-voting shares, as required by the corporate articles and consistent with principles of shareholder equity in corporate governance. Telus also argued that Mason Capital is not a shareholder invested in the future of the company but is motivated through short-term interest and financial gain almost as a game by shorting the stock of Telus even as it invested in Telus shares.
Policy makers and regulators should address these issues. Financial innovations that allow investors to vote on and influence company policy disproportionately to economic interests in the company were never contemplated by legislators and regulators in existing corporate and securities legislation, but rather balanced different interests in an operating concern. (see 14 September 12 Telus Empty Voting Decision, by Carol Hansell and J. Alexander Moore, Davies Ward Phillips & Vineberg [http://www.dwpv.com/en/Resources/Publications/2012/TELUS-Empty-Voting-Decision]) Should investors who use short-selling, credit default swaps and other financial transactions and activities for short-term gain or outcomes that negatively impact the company be given the same rights and privileges as other shareholders? Does this expression of shareholder voting actually pervert shareholder democracy? A colleague, David Fushtey [ Senior Fellow, Centre for Corporate Governance and Risk Management, Beedie Business School] asks whether there is a regulatory approach which could be used similar to approaches that address conflicts of interests. In circumstances such as this when a shareholder is perceived as being in conflict of interest, we could call on practices which have evolved to balance interests including that of credibility in the larger marketplace. A simple example is that a response to such a conflict would be to require the shareholder(s) to recuse themselves from voting in the matter in question.
These are not issues that can be easily addressed through policy. If policy makers want to discourage or prevent “empty voting” of this type, what can be done? The choices are fairly limited. Regulators could pro-rate an investor’s position in a way that only acknowledges or credits a net long position. This seems to be a fairly radical and administratively onerous approach, yet an example of the attention this issue is getting here and abroad (eg. W.G. Ringe, “Hedge Funds and Risk-Decoupling-The Empty Voting Problem in the European Union” (Aug,2012) [http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2135489]. Alternatively, regulators could assess empty voting on a case-by-case basis perhaps using a conflicts analysis or threshold to trigger an assessment. Perhaps the most workable idea in dealing with empty voting is to put the onus on shareholders to disclose structures that may lead to empty voting. This is something that European and US regulators are currently contemplating.
But what about here in Canada? Not only do current laws on disclosure make it difficult to know the extent and nature of the empty voting problem in Canada, if policy makers did want to implement policy reform, it is a much more complicated process to succeed in those policy reforms than it is in the US or even Europe. National legislative and regulatory changes are challenged by our fragmented securities regulatory regime in the absence of a national regulator as all 13 regulators in Canada would need to address the problem in some coordinated fashion. (see A National Securities Regulator and the Proposed Canadian Securities Act: Is Politics Taking Precedent Over Good Corporate Governance and Regulation? Robert Adamson November 26th, 2010, Centre for Corporate Governance and Risk Management Blog).
Despite these challenges, the Telus legal battle brings to light an important corporate governance issue for both Canadian companies and investors. Some balance must be found between two important and sometimes competing interests: that of boards and management to act in the best interests of the company within a business judgment standard, and the rights of shareholders to reasonably oversee their investments through rights granted under statute. But in an era of hedge funds, short-term arbitrage strategies and other financial innovations, work-arounds and techniques, it may become more critical to differentiate somehow the types and motivations of shareholders. At the very least, more transparency and disclosure around the identity of not just registered agents but the principal shareholders engaged in empty voting may be a preliminary and relatively painless way to start.
* with thanks to David Fushtey and Michael Parent for their suggestions and contributions.