Corporate Governance

Kurz v. Holbrook: Shareholder Voting, Omnibus Proxies, and the Role of DTC: Having It Both Ways

By J Robert Brown Jr.

Whatever the logic of the decision (and it is hard to complain about a decision trying to sidestep the formality of the omnibus proxy), the consequences are far reaching.  

By merging the Cede breakdown with the stock ledger, the court effectively transformed the DTC participants into record owners.  This would mean that street name owners wishing to vote shares or exercise appraisal rights need only contact their broker for the relevant documentation.  The conclusion effectively overturns the reasoning in Transkaryotic, 2007 Del. Ch. LEXIS 57  and the court's determination that for appraisal purposes, what mattered was the number of shares in Cede eligible for appraisal, not the number of shares eligible at each broker or banks.  Similarly, dividends now paid to Cede could be paid directly to brokers and banks. 

The court in Kurz, however, tried to have it both ways, avoiding the full implications of the decision.  The opinion apparently contemplates that companies (and street name owners) can treat as owners either brokers or Cede.  As the decision noted:

• We can just as easily recognize that Cede is the nominee of DTC acting on behalf of its participant member banks and brokers. Beneficial holders will simply have an alternative. They can either act through Cede, as they do now, or they can act through a bank or broker that appears on the Cede breakdown. The same flexibility is available to corporations, who can continue to take advantage of the administrative role DTC plays in matters like the distribution of dividends, or choose to deal directly with the banks and brokers who appear on the Cede breakdown.

It is hard to understand the basis for this conclusion.  Either the breakdown is part of the record list or it isn't.  To the extent that it is, brokers and banks are the record owners, not Cede.  Giving shareholders an "alternative" is effectively allowing them to choose who gets to be the record owner.  This will create confusion and uncertainty with respect to the stock ledger.

This will be problematic with respect to appraisal rights.  These rights must be exercised by the record owners. See 8 Del. C. § 262; see also In re Appraisal of Transkaryotic Therapies, Inc., 2007 Del. Ch. LEXIS 57 (Del. Ch. May 2, 2007).  This means that under the reasoning in Kurz, brokers and banks, not Cede, have the right to exercise appraisal rights.  There is no element of choice involved.

Moreover, providing choice would allow some beneficial owners to invoke appraisal rights through brokers and others to rely on Cede.  Because the Cede shares are really owned by brokers and other participants, appraisal rights submitted by the depository in reality reduce the number of shares otherwise available to participants.  Unless the shares submitted by Cede can be subtracted from the totals of specific participants, there is the risk that more shares will be submitted than were perfected for purposes of appraisal rights. 

Combining the breakdown with the stock ledger has a nice logic and does dispense with the formality of the omnibus proxy.  But the same analysis makes it very difficult to understand how Cede can have any continuing role in the process.  

For more on the entire system of beneficial ownership and the role of the depositories, see The Shareholder Communication Rules and the Securities and Exchange Commission: An Exercise in Regulatory Utility or Futility?  The opinion and a number of primary materials are posted at the DU Corporate Governance web site.

Full post as published by The Race to the Bottom on March 19, 2010 (boomark / email).