By Alex Moore
Davies Ward Phillips & Vineberg LLP1
The proxy fight between Agrium Corporation and its largest shareholder, JANA Partners LLC, was the most high profile proxy contest in Canada in 2013. JANA was critical of Agrium's capital allocation and the underperformance of Agrium's retail and distribution business. Agrium, in turn, staunchly defended its record and its integrated strategy. After failed settlement discussions in February, the parties engaged in a hard-fought proxy contest that ended with Agrium's management slate gaining reelection.
The most high profile issue in the Agrium proxy fight arose late in the contest when Agrium's payment of fees for favorable votes was discovered and publicly revealed by JANA. Though soliciting dealer fees (as such fees are known) have been somewhat common outside of contested director elections (such as in the context of approval of M&A transactions), Agrium's payment of fees to brokers and dealers for facilitating votes in favor of the election of its incumbent nominees generated intense media attention as well as criticism from Agrium shareholders and the general investing public and raises questions about the propriety of the practice.
THE ORIGIN OF SOLICITING DEALER FEES
Soliciting dealer fees have been employed for many years in the context of take-over bid transactions. In take-over bid transactions, bidders often seek to obtain 100 per cent equity ownership and to achieve that goal condition their bid on a minimum percentage of the outstanding shares being tendered to the bid. A typical minimum tender condition would require that at least 66 2/3 per cent of outstanding shares be tendered in order that the bidder may subsequently carry out a second step squeeze-out of non-tendering shareholders. In some cases, to increase the likelihood of reaching the minimum tender condition, the bidder retains a dealer manager to form a group of “soliciting dealers” who will receive compensation, usually in the form of a per share commission, for soliciting the tendering of shares to the bid.
Soliciting dealer fees are typically offered to all members of the Investment Industry Regulatory Organization of Canada (IIROC), meaning that, in effect, the fees are offered to all registered Canadian broker-dealers. These broker-dealers then have an incentive to make outbound calls to clients to seek instructions to tender shares to the bid.
While the payment of soliciting dealer fees is generally not problematic in take-over bids that have wide shareholder support, the impact that the fees have on the success of bids that are viewed as undervalued or in the context of competing transactions has prompted some to criticize the practice, objecting that the fees compromise the ability of brokers to provide unbiased advice to shareholders on whether to tender to a bid. Despite this criticism, regulators have not taken any steps to curtail the practice.
Over the years, soliciting dealer fees have also become fairly common in M&A transactions that proceed by way of plan of arrangement, an alternative transaction structure to a take-over bid. In a plan of arrangement, shareholders do not tender their shares but rather are asked to vote in favor of the transaction. If a soliciting dealer fee is offered to encourage approval of a transaction, the target or the purchaser pays the soliciting dealers a per share fee for votes submitted in favor of the transaction. Although analogous to a soliciting dealer fee offered in the take-over bid context, there is a notable distinction in the rationale for offering the fee in connection with a vote on a plan of arrangement in that the fate of the transaction is usually not dependent on a minimum level of participation in the vote (the minimum quorum requirement rarely being an obstacle). In contrast, shareholder participation is usually determinative of the success of a bid as a bidder must attain a certain minimum level of ownership of the outstanding shares in order to effect the squeeze-out.
SOLICITING DEALER FEES IN CONTESTED DIRECTOR ELECTIONS
Despite the variety of situations in which soliciting dealer fees have been paid, until 2012, the use of soliciting dealer fees in Canada had been limited to corporate transactions and had never been used in proxy fights relating to the election of a board of directors. That changed in the spring of 2012 during the proxy contest between management of EnerCare Inc. and its largest shareholder, Octavian Advisors. Less than two weeks prior to its shareholders meeting, EnerCare announced that it would pay a solicitation fee of C$0.05 for each share voted by retail shareholders against Octavian's board nominees. Octavian immediately objected to the tactic, accusing the EnerCare board of “a cynical plan to buy votes at shareholders' expense” and labeling the soliciting dealer fee offer “an extraordinary abuse of power and waste of company resources that highlights the lengths to which the current directors will go to further entrench themselves.”
Because of the low profile of the EnerCare contest there was little notice of EnerCare's soliciting dealer fees beyond those involved in the contest. Moreover, because the votes of retail shareholders were not material to EnerCare's ultimate success at the meeting, Octavian did not further pursue the issue.
AGRIUM'S SOLICITING DEALER FEES AND MARKET REACTION
In contrast to the EnerCare contest, the discovery by JANA Partners of the soliciting dealer fees offered by Agrium in its 2013 proxy contest generated intense media coverage and reaction from shareholders and focused an unprecedented amount of attention on the propriety of the practice in general.
As in EnerCare, Agrium did not enter into a soliciting dealer arrangement until after it had already mailed its management information circular for its April 9th shareholders meeting. Agrium's circular mailed on March 4, 2013, only stated that Agrium “may cause a soliciting dealer group to be formed, and pay customary fees for such services.”
Subsequently, on March 13, 2013, RBC Capital Markets, as Dealer Manager for Agrium, produced a confidential Soliciting Dealers Information Memorandum that urged other brokers to solicit proxies in favor of Agrium's incumbent nominees. The Information Memorandum also detailed Agrium's offer to pay members of the Soliciting Dealers Group who facilitated the voting of shares by Agrium's Canadian retail shareholders a fee of C$0.25 per share for each share voted in favor of the Agrium nominees, subject to minimum and maximum fees per beneficial owner of C$100 and C$1,500 respectively. No payment would be made in respect of any shareholder that did not vote for all Agrium nominees. Moreover, all fee payments were subject to the condition that Agrium's slate of nominees be fully elected to the Board. The Soliciting Dealers Information Memorandum was stamped for “Internal Use Only” and bore a legend that prohibited recipients from reproducing the contents of the document or distributing the contents to the public or the press.
Whereas EnerCare had issued a press release announcing that it was offering to pay soliciting dealer fees, Agrium made no public disclosure of the arrangements it had entered into. Through its own solicitation efforts JANA eventually learned of Agrium's soliciting dealer fees, but only after 18 days from the date of the Soliciting Dealers Information Memorandum and just five days prior to the proxy cut-off date for the shareholders meeting. JANA immediately issued its own press release disclosing the soliciting dealer fees and accusing the Agrium Board of spending shareholder capital to buy votes to ensure their own re-election. JANA also noted the conflict of interest that the fees created for brokers and financial advisers and called on them to terminate the arrangements and inform their clients of Agrium's agreement to compensate them for securing favorable votes.
Due to the high profile of the Agrium contest, public reaction to the revelation of Agrium's soliciting dealer fees was swift and intense, with financial columnists and broadcasters being highly critical of Agrium. The Globe and Mail newspaper published an editorial criticizing the Agrium Board for the practice and calling for a regulatory ban. While much of the criticism focused on the actions of the Agrium Board, the willingness of brokers to accept fees that could place them in a conflict of interest with the shareholders they advise also troubled commentators.
Following the Agrium meeting, the Canadian Coalition for Good Governance, an influential organization representing Canadian institutional investors, publicly condemned the use of soliciting dealer fees in an op-ed piece in The Globe and Mail, asserting that “Agrium's ‘vote buying' was inconsistent with the basic tenets of shareholder democracy and the fiduciary duties of directors.”
THE LEGALITY OF SOLICITING DEALER FEES
The Agrium case warrants a closer legal analysis of the legality of soliciting dealer fees, both in the context of a contested director election and also generally in the context of approval of an M&A transaction where they are commonly paid.
Although no rule specifically forbids directors from compensating brokers for facilitating favorable votes, directors of course must at all times in exercising their authority comply with fiduciary duties to act honestly and in good faith with a view to the best interests of the corporation.2 In a context where the directors are charged with overseeing the conduct of a proxy fight that concerns their own re-election there is a serious question as to whether it is in the best interests of the corporation to use corporate funds to compensate brokers for obtaining votes solely in their favor.
In any proxy contest, the directors will use the corporation's resources to persuade shareholders to support the management side, for example by hiring public relations firms to help spread the board's message and advance the board's case against the dissident's agenda. If the board of directors has determined that the dissident's nominees or the dissident's agenda are not preferable to the board's own nominees and agenda, then the board has an obligation to provide shareholders with its views and analysis and advance its recommendation that shareholders reject the dissident's proposals. However, ultimately, it is the shareholders, after absorbing information provided by both sides, who determine the outcome of the contest. A belief by the directors that their own nominees and strategy are preferable to those of the dissident, even though arrived at honestly and in good faith, does not give the directors license to employ any means necessary to ensure their success in the proxy contest. Even if the directors can demonstrate reasonable grounds for their belief of the dissident's threat to the company, under general fiduciary principles the actions of the directors in responding to the threat must be within a range of reasonable alternatives.3 (If a board could resort to any means necessary to ensure what they see as the “right result” at a shareholders meeting, then the need for a shareholder vote would be superfluous — and the question of who is best fit to run the corporation would be left to the directors.)
The range of actions available to the board to respond to a dissident's threat must contend with the holding of the Supreme Court of Canada in Blair v. Consolidated Enfield Corp. that the best interests of the corporation in the context of a contested shareholder meeting center “solely on the maintenance of the integrity and propriety of the voting procedure”.4 While the facts in that case concerned the conduct and decisions of the chair of a contested meeting, the same interests should apply to the full board and also the officers of the corporation with respect to the panoply of decisions that they make earlier in the election process, including decisions as to how proxies will be solicited by management. Clearly, communicating with shareholders and ensuring they are fully informed of management's views is consistent with maintaining an effective voting procedure. However, the use of corporate funds to compensate members of a soliciting dealer group is very different than the usual steps that a corporation might take to communicate with and inform shareholders. The offering of incentives to brokers creates financial incentives for brokers both (i) to reach out to their clients to obtain voting instructions, and (ii) to encourage clients to vote in favor of the management slate, regardless of (and potentially inconsistent with) the broker's own independent assessment of the best option for the client. In this way, the fees undermine the integrity of the voting process.
The directors' fiduciary duty requires that when they exercise a corporate power they must do so for a proper purpose. Using their corporate power for the primary purpose of entrenching themselves is clearly an improper purpose.5 The payment of soliciting dealer fees that are not contingent upon support for management or management's success might be considered consistent with a proper purpose of increasing retail shareholder participation in a vote. However, conditioning payments on support for and re-election of management nominees belies that voter participation generally is the primary purpose of the arrangement.
Outside of a contested board election, a board of directors might be able to show that it has a proper purpose in paying soliciting dealer fees for votes in favor of approval of a proposed M&A transaction. The board in recommending an M&A transaction can usually point to the recommendation of an unconflicted board of directors or committee of the board that has determined that the transaction is in the best interests of the corporation. In these situations, board entrenchment is usually not at issue. And, to the extent that continuation of the corporation's board following the transaction is a feature of the transaction that, a skeptic might say, would influence the directors' enthusiasm for it, the directors in those circumstances can at least point to a legitimate primary purpose for their support that legitimizes their use of corporate funds to pay soliciting dealer fees. This cannot be said for a shareholder vote where the sole issue is the composition of the board of directors. However, even where a board cannot be accused of entrenching itself and can point to a proper purpose for offering soliciting deal fees for the approval of a transaction, issues regarding the impact of the fees on the integrity of the voting process could still be a concern under a fiduciary duty analysis. These concerns would be heightened where the transaction in question faces shareholder opposition.
The basis for a fiduciary duty challenge to a board's use of soliciting dealer arrangements could also form the basis for a claim under the oppression remedy. As a broad shareholder remedy that protects the “reasonable expectations” of shareholders, an oppression remedy challenge would be a natural option for an aggrieved dissident shareholder to pursue.
The oppression remedy is focused on concepts of fairness and equity rather than on legal rights,6 thus no demonstration of breach of any law is required. A shareholder could likely advance a strong argument that the use by management of corporate resources to offer compensation that has the effect of influencing the advice that is provided to shareholders as to how to vote is inconsistent with the reasonable expectations of shareholders as to how a contested vote would be conducted and unfairly prejudices the interests of shareholders opposed to management.
The potential for conflicts of interest on the part of participants in the voting machinery to taint the voting process has been previously considered in the oppression remedy case International Energy and Mineral Resources Investment v. Mosquito Consolidated Gold Mines.7 In that case, a system in which a proxy solicitation firm obtained oral voting instructions by telephone was invalidated by the British Columbia Supreme Court in part because of the conflict of interest issues that arose from the solicitation firm, an agent of management, also seeking to act as an agent of the shareholder in executing on oral voting instructions. The court also noted that the acceptance of oral voting instructions by management created an obvious imbalance in the way votes were taken between management and the dissident group giving rise to an unfair advantage. Similar issues of conflict of interest and imbalance arise from the use of soliciting dealer fees.
Application of Canadian Proxy Solicitation Rules to Soliciting Dealer Arrangements
Canadian corporate and securities laws prohibit any person from engaging in proxy solicitation without mailing to shareholders a proxy circular containing prescribed information, including the disclosure regarding specially engaged soliciting agents. The definition of what constitutes “solicitation” is notoriously broad and includes “requesting a securityholder to execute or not execute a form of proxy” and the sending of any “communication to a securityholder under circumstances that to a reasonable person will likely result in the giving, withholding or revocation of a proxy.”
Actions by soliciting dealers to secure votes in favor of the re-election of incumbent directors are clearly acts of solicitation. Thus, by participating in a soliciting dealer group, a broker must comply or be exempt from the requirement to provide shareholders solicited with an information circular containing, among other things, information regarding its engagement to solicit on behalf of management and the terms thereof.
Brokers and advisers enjoy an exemption (which I have dubbed the “advisory exemption”) from the definition of “solicitation” in National Instrument 51-102 – Continuous Disclosure Obligations (“NI 51-102”) if they give “financial, corporate governance or proxy voting advice in the ordinary course of business”.8 The purpose of the advisory exemption is to allow brokers and financial advisers, as well as proxy advisory firms such as Institutional Shareholder Services and Glass, Lewis & Co., the freedom to provide their clients with voting advice without having to worry about compliance with the proxy solicitation rules. While brokers would clearly qualify as giving financial, corporate governance or proxy voting advice in the ordinary course of their business, the terms of a typical soliciting dealer arrangement, and the arrangement that Agrium entered into with its soliciting dealer group, would fail to satisfy at least two of the conditions to the advisory exemption: namely that 1) the exemption is not available for solicitations conducted on behalf of management or on behalf of any other person soliciting proxies, and 2) brokers relying on the advisory exemption may not receive any compensation for providing the proxy voting advice other than from the shareholders receiving the advice.
Comparison to US Proxy Solicitation Requirements
The definition of “solicit” in Rule 14a-1 under the US Securities Exchange Act of 1934 is substantially identical to the definition of “solicit” in NI 51-102. In addition, the disclosure required in a proxy circular regarding the use of soliciting agents is substantially similar to Canadian form requirements.
It is interesting to note that the advisory exemption, which was introduced to the Canadian proxy solicitation rules as an amendment to NI 51-102 in 2007, tracks closely a similar exemption from the Securities and Exchange Commission's proxy solicitation rules in Rule 14a-2(b)(3) under the US Securities Exchange Act of 1934. The exemption in Rule 14a-2(b)(3) for brokers and advisers contains substantially the same conditions as under the Canadian advisory exemption discussed above, including the condition that the adviser receive no special commission or remuneration for the proxy voting advice from any person other than recipients of the advice.
Despite the close parallels between the proxy solicitation rules in the US and Canada, US broker-dealers have taken a very different approach to their role in the facilitation of voting by their clients than the approach in Canada. In contrast to the Canadian practice of participating in soliciting dealer groups, US broker-dealers have governed themselves on the basis that they must be careful not to engage in solicitation when providing their clients with voting advice. Even in proxy solicitations involving Canadian issuers, US broker-dealers will routinely decline to participate in soliciting dealer groups formed by their Canadian counterparts.
One reason for the distinction between Canadian and US practice is likely the desire by US broker-dealers to avoid being subject to the SEC's filing and other rules that apply to those engaged in proxy solicitation. However, another reason for the different approach is the more stringent legal duty of investment advisers and brokers under US law to their clients. Canadian securities legislation imposes a duty on registered advisers and dealers to deal “fairly, honestly and in good faith” with their clients9, a standard that is generally viewed as falling short of a “best interests” (i.e., fiduciary) standard. In comparison, in the United States investment advisers must act in the best interests of their clients, a fiduciary standard, and in some circumstances brokers have also been held to a fiduciary standard. The more stringent fiduciary standard prohibits an adviser or broker from putting himself in a position antagonistic to his client.10 Accepting compensation from a third party for facilitating the vote of a client would likely be seen as inconsistent with this principle.
Questions of the Public Interest
Although the different legal standards applicable to individual client relationships might explain the willingness of Canadian brokers to act as soliciting dealers, the consequences to investors generally of soliciting dealer arrangements could raise issues under the public interest jurisdiction of the provincial and territorial securities commissions. Under the securities regulators' public interest jurisdiction, even where actions by a market participant do not contravene any provision of the securities legislation, the securities commissions may nevertheless intervene and sanction behavior that they determine to be abusive of the integrity of the capital markets.11
The nature of soliciting dealer arrangements is that they typically invite participation by all IIROC-registered dealers. Thus, all Canadian retail broker-dealers are offered compensation for facilitating votes of their clients. If one accepts that the compensation of retail brokers to facilitate votes only in favor of one side in a contested election or transaction could give rise to a bias on the part of the retail brokers providing voting advice, then one of the consequences of the formation of a soliciting dealer group may be to taint virtually all voting advice that Canadian retail shareholders receive from their brokers. The lack of sophistication on the part of many retail clients exacerbates the issue: those shareholders who might be most in need of independent advice with respect to a voting decision are denied the ability to get advice from their broker or adviser that is unbiased. This broad impact of soliciting dealer arrangements on the ability of shareholders to get unbiased advice could inform a view that they are abusive of the integrity of the capital markets.
Whether securities regulators would be inclined to invoke their public interest jurisdiction to preclude registered dealers and advisers from participating in soliciting dealer arrangements is uncertain. On the one hand, the practice in the context of M&A transactions has been part of the landscape in Canada for many years. On the other hand, the controversy created by Agrium's payment of soliciting dealer fees has focused unprecedented attention on the propriety of dealers and advisers accepting such compensation, not just in the context of contested director elections, but generally. Moreover, even before the Agrium vote buying issues arose, Canadian securities regulators were already exploring whether it would be appropriate to introduce a “best interests” duty for advisers and dealers who provide advice to retail investors. Adoption of this higher standard would require dealers and advisers to revisit whether they could properly participate in soliciting dealer arrangements and satisfy a best interests standard. But even in the absence of a change in the nature of the duty, the interest of Canadian securities regulators in the relationship between dealers and advisers and their retail clients suggests that regulators might nevertheless consider targeting specific industry practices that are contrary to the interests of retail investors.
The reaction of the press and the investing public to Agrium's use of soliciting dealer fees in its proxy fight with JANA will likely result in heightened sensitivity to the use of the practice and could lead securities regulators to propose rules or guidance that would curtail the practice altogether. Even in the absence of any regulatory response however, the Agrium case should cause boards to re-evaluate whether compensating brokers for facilitating favorable votes is a sound tactic that they should be keeping in their proxy contest tool-kit. In addition to the question of whether the practice is consistent with the discharge of their fiduciary duties, boards must also consider the risk that the payment of soliciting dealer fees might alienate shareholders and could even influence the ever-important recommendations of proxy advisory firms such as Institutional Shareholder Services and Glass, Lewis & Co. Given the predictable negative shareholder reactions to the practice, the advantages that boards might seek to attain in paying soliciting dealer fees could easily be erased by providing ammunition to their opponents in winning the hearts and minds of the shareholder base.
- The author and his firm represented JANA Partners LLC in the Agrium proxy contest.
- Canada Business Corporations Act (“CBCA”), Section 122(1)(a)
- In re BCE Inc.  3 S.C.R. 560 at para 40 (“BCE”).
-  4 S.C.R. 5
- Canadian Jorex Ltd. v. 477749 Alberta Ltd.(1991), 4 B.L.R. (2d) 174 (Alta. C.A.) at 178; Oppenheimer & Co. v. United Grain Growers Ltd.,  M.J. No. 510 (Man. Q.B.)
- BCE at 71.
- 2012 BCSC 1191.
- There is a substantially similar exemption in section 68(1)(c) of the Regulations under CBCA.
- E.g., see section 2.1 of OSC Rule 31-505 – Conditions of Registration.
- O'Malley v. Boris, 742 A. 2d 845 (Del. Supr. Ct.; 1999); and Science Accessories v. Summagraphics, Del. Supr. Ct., 425 A.2d 957 (1980).
- Committee for the Equal Treatment of Asbestos Minority Shareholders v. Ontario (Securities Commission) ,  2 S.C.R. 132.2014