Why Einhorn’s Win May Be Apple’s Gain

David Einhorn, founder of the hedge fund Greenlight Capital. Mike Segar/ReutersDavid Einhorn, founder of the hedge fund Greenlight Capital.

Greenlight Capital and David Einhorn’s victory against Apple in Federal District Court in Manhattan is a small one, serving only to highlight the bizarreness of the entire fight. The odd thing is that the result is actually more of a win for Apple than Mr. Einhorn, and the outcome will probably have a bigger effect on other companies.

To understand the importance of the case, it is necessary to go through what happened in the courtroom.

Apple had proposed to amend its certificate of incorporation to make what it claimed to be two shareholder friendly amendments. The biggest amendment was no doubt to clear the way for a majority vote requirement for Apple’s directors. But a second amendment proposed to eliminate the ability of directors to issue preferred stock.

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The second proposal was quite unusual, as few companies had ever taken this step. Given this – and Apple’s less-than-friendly shareholder governance – it was hard not to see why Mr. Einhorn made a move. In the course of this battle, Mr. Einhorn called on Apple to issue what he called iPref’s, tens of billions of dollars’ worth of preferred shares that he claimed would unlock Apple’s huge cash hoard. (I wrote more about this proposal and this battle a few weeks ago.

Had the proposal gone to a vote at the shareholder meeting on Wednesday, Mr. Einhorn would likely have lost and the charter would have been amended. So he took a different tactic. He sued.

In the complaint, Greenlight Capital claimed that Apple’s proposal violated the unbundling rules of the Securities and Exchange Commission, which require that a shareholder ballot must “identify clearly and impartially each separate matter intended to be acted upon, whether or not related.” The rules also dictate that a “person solicited is afforded an opportunity to specify by boxes a choice between approval or disapproval of, or abstention with respect to each separate matter referred to therein as intended to be acted upon.” They are known as the unbundling rules because they effectively require that shareholders be allowed to separately express their views to the board without being coerced into voting for issues they would not support.

If you are not up to speed on these rules, you are not alone. There have only been a few court cases on the issue, and very little S.E.C. guidance on what constitutes bundling.

The only major guidance is an S.E.C. release from 2004 about bundling in votes on mergers. In that release, the S.E.C. indicated that bundling would occur where approval on a merger was grouped with approval of a material change to a company’s certificate of incorporation.

From this S.E.C. guidance, bundling appears to refer to two substantive matters lumped together.

On that basis, Mr. Einhorn’s complaint is not frivolous. Apple had combined a number of proposals as one – and even described them as separate in its proxy.

But the flip side of this argument was the one made by Apple itself – that this was merely an amendment to a certificate, which had the effect of enacting several changes to the charter. And Apple had the side of practice, if not precedent. Companies amend their certificates all the time, changing numerous terms in one vote.

While the judge struggled with the lack of precedent on the issue, he ultimately ruled for Mr. Einhorn. In doing so, he relied on a treatise that cited unwritten S.E.C. guidance from before 1999. The treatise stated that aggregating separate charter amendments – if material – would constitute bundling. The judge stated:

Given the language and purpose of the rules, it is plain to the Court that Proposal No. 2 impermissibly bundles “separate matters” for shareholder consideration. Even ignoring the mere formulation of Proposal No. 2 as four distinct changes, which “alone suggests the[ir] separability,” the present bundling of items forces shareholders, including Greenlight and Gralnick, to “approve or disapprove a package of items and thus approve [or disapprove] matters they [would] not if presented independently.”

The judge’s decision, at first blush, appears to be a reasonable interpretation of the rule.

But remember that the S.E.C. has only specifically come out against two separate items bundled together – a charter amendment and a merger. When you amend your charter, you are really only doing one thing with the ancillary effect of making changes to a company’s governance. And companies have amended their charters thousands of times.

In essence, the court is saying companies will have to change how they amend their certificates. Every term will now need to be broken out separately.

But corporate governance is not so neat.

When you look harder, the judge’s ruling goes quite far, maybe farther than the unbundling rules intended. A charter amendment is not about two different substantive acts. It is rather an individual charter vote that includes two or more proposals. There is a difference.

Nonetheless, perhaps the Apple case can be isolated as a problem of how it drafted the proposal. The company did describe the proposal as encompassing separate items, making Mr. Einhorn’s case much stronger.

But the bottom line is that, given how this disrupts the ability of a company to amend its charter, the S.E.C. will probably have to clarify things. If a company now decides to completely rewrite its charter, will every term now have to be broken out for a separate vote? What a hassle.

Ultimately, though, other than this headache for other companies, Mr. Einhorn’s win does not change a thing in the fight with Apple. Apple still has its cash hoard of roughly $140 billion, and Mr. Einhorn still wants the company to take more novel steps to monetize it.

If Apple had won this round, then shareholders would probably have approved Apple’s proposal, meaning that the board could no longer just unilaterally issue preferred shares. Instead, Apple shareholders would have had to vote on the matter, making it harder for Mr. Einhorn to get the proposal through.

As it stands now, the decision on whether to adopt Mr. Einhorn’s iPref’s proposal will remain with Apple’s board, which does not seem keen to do so. And remember, Apple’s chief executive, Timothy D. Cook, called the proposal “silly.”

Regardless of what happened in court, the cash issue remains. But now, the company does not have to implement shareholder friendly amendments in the form of majority voting for directors or requiring that shareholders must approve the issuance preferred stock. Apple had previously resisted such efforts, and probably only put the majority director proposal forward as cover for the preferred share proposal.

So Apple really is getting what it wants – which is to not have to add majority voting for directors. And instead of being labeled bad for shareholder governance, the company can blame Mr. Einhorn.

If you are shaking your head at this point, so am I. But that is what it’s like in the age of celebrity hedge funds.

These battles may often lack substance, but there is a lot of flash and distraction, sort of like the Kardashians. One wishes Apple could be allowed to go back to doing what it does best – making money by making things – instead of being caught up in Wall Street’s machinations.