Date Submitted: May 11, 2015.
Date Revised: July 30, 2015.
Stuart M. Grant, Michael J. Barry, Christine M. Mackinstosh, Jennifer A. Williams, Rebecca A. Musarra, GRANT & EISENHOFER P.A., Wilmington, Delaware; Attorneys for Petitioners Curtiss-Wright Corporation Retirement Plan; Manulife U.S. Large Cap Value Equity Fund; The Milliken Retirement Plan; Northwestern Mutual Series Fund, Inc., on behalf of its Equity Income Portfolio; and T. Rowe Price Funds SICAV U.S. Large Cap Value Equity Fund.
Gregory P. Williams, John D. Hendershot, Susan M. Hannigan, Andrew J. Peach, RICHARDS, LAYTON & FINGER, P.A., Wilmington, Delaware; John L. Latham, Susan E. Hurd, ALSTON & BIRD LLP, Atlanta, Georgia; Gidon M. Caine, ALSTON & BIRD LLP, East Palo Alto, California; Charles W. Cox, ALSTON & BIRD LLP, Los Angeles, California; Attorneys for Respondent Dell Inc.
LASTER, Vice Chancellor.
The petitioners are five institutions who owned common stock of Dell Inc. They sought appraisal after Dell announced a going-private merger. Dell contends that they did not hold their shares continuously through the effective date of the merger and therefore lost their appraisal rights.
The Funds held their shares through custodial banks. By virtue of this relationship, the Funds did not have legal title to the shares; they were beneficial owners. But the custodial banks did not have legal title either. The shares they held were registered in the name of Cede & Co., which is the nominee of the Depository Trust Company ("DTC").
DTC's place in the ownership structure results from the federal response to a paperwork crisis on Wall Street during the late 1960s and early 1970s. Increased trading volume in the securities markets overwhelmed the back offices of brokerage firms and the capabilities of transfer agents. No one could cope with the burdens of documenting stock trades using paper certificates. The markets were forced to declare trading holidays so administrators could catch up. With trading volumes continuing to climb, it was obvious that reform was needed. Congress directed the SEC to evaluate alternatives that would facilitate trading.
After studying the issue, the SEC adopted a national policy of share immobilization. To carry out its policy, the SEC placed a new entity-the depository institution-at the bottom the ownership chain. DTC emerged as the only domestic depository. Over 800 custodial banks and brokers are participating members of DTC and maintain accounts with that institution. DTC holds shares on their behalf in fungible bulk, meaning that none of the shares are issued in the names of DTC's participants. Instead, all of the shares are issued in the name of Cede. Through a Fast Automated Securities Transfer account (the "FAST Account"), DTC uses an electronic book entry system to track the number of shares of stock that each participant holds.
By adding DTC to the bottom of the ownership chain, the SEC eliminated the need for the overwhelming majority of legal transfers. Before share immobilization, custodial banks and brokers held shares through their own nominees, so new certificates had to be issued frequently when shares traded. With share immobilization, legal title remains with Cede. No new certificates are required.
Although the depository system solved the paperwork crisis, it complicated other aspects of the legal system. Appraisal is one of those areas. When a transaction triggers appraisal rights, Section 262 of the Delaware General Corporation Law (the "DGCL") permits "[a]ny stockholder of a corporation" who complies with its requirements to litigate a proceeding that will result in a judicial determination of the "fair value of the shares." 8 Del. C. §§ 262(a) & (h). The statute states that "[a]s used in this section, the word 'stockholder' means a holder of record of stock in a corporation." Id. § 262(a) (the "Record Holder Requirement"). One of the statutory requirements is that a stockholder who wishes to pursue appraisal must "continuously hold such shares through the effective date of the merger." Id. (the "Continuous Holder Requirement").
Many appraisal decisions have involved disputes over these requirements. In one recurring scenario, companies argued that a petitioner had lost its appraisal rights when DTC followed its usual procedures, surrendered the shares held in fungible bulk for the merger consideration, and distributed the merger consideration to its participants, who then deposited it in their customers' accounts. In Alabama By"Products Corp. v. Cede & Co., 657 A.2d 254 (Del. 1995), the Delaware Supreme Court held that if a petitioner had properly perfected its appraisal rights through Cede, then the petitioner would not lose its appraisal rights if DTC surrendered the shares in exchange for the merger consideration. The court reached this conclusion because the surrender did not comply with the appraisal statute's requirements for withdrawing or settling a properly perfected appraisal claim. The practical effect of this decision was to "impose upon the corporation the responsibility of overseeing the surrender of shares after a merger." Id. at 263.
To help issuers oversee the surrender of shares, DTC modified its procedures. Now, when a beneficial owner causes Cede to demand appraisal, DTC removes the shares covered by the demand from the fungible bulk tracked in the FAST Account. DTC does this by causing the issuer's transfer agent to issue a paper stock certificate for the number of shares held by the beneficial owner. The paper certificate is issued in Cede's name, so the same record holder continues to hold the shares for purposes of the Continuous Holder Requirement.
In this case, DTC followed its procedures and issued paper stock certificates in Cede's name for the Funds' shares. DTC then contacted the custodial banks to make arrangements for delivering the resulting valuable pieces of paper. But here another backoffice procedure kicked in. For various understandable business reasons (insurance requirements, recordkeeping for internal audit, mitigating risk of theft, etc.), some banks and brokers only hold stock certificates that are issued in the names of their own nominees. The Funds' custodial banks followed this policy.
When DTC contacted the custodial banks, each instructed Dell's transfer agent to record a transfer of the shares to its nominee and issue a certificate in its nominee's name. Dell's transfer agent complied. The Funds remained the beneficial owners. The custodians remained the custodians. But now there were new nominees on the stock ledger.
Dell has moved for summary judgment, arguing that these back-office steps resulted in new record holders and broke the chain of title for purposes of the Continuous Holder Requirement. Under Delaware cases that pre-dated the federal policy of share immobilization, the record holder for purposes of the DGCL was the person that appeared on the stock ledger. After the SEC created the depository system, the Delaware courts adhered to this rule. They did not distinguish the voluntary relationship between a client and its custodial bank or broker (the "broker level" of ownership) from the federally mandated relationship between the custodial bank or broker and DTC (the "depository level" of ownership). Delaware cases simply treated Cede as the holder of record and applied the Continuous Holder Requirement strictly. Under these decisions, the motion must be granted.
A different approach is possible and, in my view, preferable. Federal law looks through Cede and recognizes the custodial banks and brokers as record holders, just as before the federal mandate. If Delaware law took a similar approach, the Funds would retain their appraisal rights, because ownership by the relevant DTC participants never changed. Were I writing on a blank slate, I would account for the federal policy of share immobilization by interpreting the term "stockholder of record" as used in Section 262(a) to parallel its content under the federal securities laws. In other words, the term "stockholder of record" would include a DTC participant. But that is not how our cases have interpreted the statutory term, and this court is bound by those precedents. Dell's motion for summary judgment is therefore granted.
I. FACTUAL BACKGROUND
The facts are drawn from the parties' submissions in connection with Dell's motion for summary judgment. There are no disputes of material fact about the Funds' exercise of their appraisal rights or the re-titling of their shares.
A. The Funds' Ownership Of Dell Shares
On February 5, 2013, Dell agreed to a merger in which each publicly held share of Dell common stock would be converted into the right to receive $13.75 in cash, subject to the right of stockholders to seek appraisal. The Funds held at least 922, 975 shares of Dell common stock. Like most investors, the Funds did not hold legal title to their shares. The Funds owned the shares indirectly through accounts at custodial banks. Two of the Funds used J.P. Morgan Chase ("JP Morgan") as their custodian. The others used The Bank of New York Mellon ("BONY").
The custodial banks did not own record title either. JP Morgan and BONY are two of more than 800 custodial banks and brokers who are participating members of DTC.
The vast majority of publicly traded shares in the United States are registered on the companies' books not in the name of beneficial owners- i.e., those investors who paid for, and have the right to vote and dispose of, the shares-but rather in the name of "Cede & Co., " the name used by The Depository Trust Company ("DTC").
Shares registered in this manner are commonly referred to as being held in "street name." . . . DTC holds the shares on behalf of banks and brokers, which in turn hold on behalf of their clients (who are the underlying beneficial owners or other intermediaries).
John C. Wilcox, John J. Purcell III, & Hye-Won Choi, "Street Name" Registration & The Proxy Solicitation Process, in A Practical Guide to SEC Proxy and Compensation Rules 10-3, 10-3 (Amy Goodman et al. eds., 4th ed. 2007 & 2008 Supp.) [hereinafter Street Name] (footnote omitted).
The history of how we arrived at this ownership structure is important and informative.
Prior to 1970, negotiation was the most common method used to transfer stock in the United States. The owner would endorse the physical certificate to the name of the assignee on the back of the certificate. This endorsement instruct[ed] the corporation, upon notification, [about] the change in ownership of the shares on its corporate books. If the parties used the services of a broker, the seller would transfer the certificate to his brokerage firm. The brokerage firm representing the customer buying the security would receive the physical certificate and transfer it to the buyer as the new record owner of the security. Occasionally, the new owner might request that the physical certificate remain at the street address of the brokerage firm to facilitate the transfer of the certificate in a subsequent sale.
Wolfe, supra, at 180 (footnotes omitted).
Transfer of securities in the traditional certificate-based system was a complicated, labor-intensive process. Each time securities were traded, the physical certificates had to be delivered from the seller to the buyer, and in the case of registered securities the certificates had to be surrendered to the issuer or its transfer agent for registration of transfer.
Prefatory Note at 2.
By the late 1960s, increased trading rendered the certificate system obsolete. The paperwork burden reached "crisis proportions." Id.
Stock certificates and related documents were piled "halfway to the ceiling" in some offices; clerical personnel were working overtime, six and seven days a week, with some firms using a second or even a third shift to process each day's transaction. Hours of trading on the exchange and over the counter were curtailed to give back offices additional time after the closing bell. Deliveries to customers and similar activities dropped seriously behind, and the number of errors in brokers' records, as well as the time to trace and correct these errors, exacerbated the crisis.
Wolfe, supra, at 181 n.49 (quoting SEC Study at 219 n.1). "The difficulty that brokers and dealers experienced in keeping their records due to the volume of transactions and their thin capitalization caused many brokerage firms to declare bankruptcy and many investors to realize losses." Id. at 182.
Congress responded by passing the Securities Investor Protection Act of 1970, which directed the SEC to study the practices leading to the growing crisis in securities transfer. 15 U.S.C. § 78kkk(g). The SEC recommended discontinuing the physical movement of certificates and adopting a depository system. Wolfe, supra, at 182 n.58 (citing SEC Study at 13). Congress then passed the Securities Acts Amendments of 1975, which directed the SEC to "use its authority under this chapter to end the physical movement of securities certificates in connection with the settlement among brokers and dealers of transactions in securities consummated by means of the mails or any means or instrumentalities of interstate commerce." 15 U.S.C. § 78q-1(e). In a resulting report, the SEC found that "registering securities in other than the name of the beneficial owner- was essential to establishing "a national system for the prompt and accurate clearance and settlement of securities transactions." Kahan & Rock, supra, at 1237 n.49.
Thus was born the federal policy of immobilizing share certificates through a depository system. "Congress called for a more efficient process for comparison, clearing, and settlement in a national market system, and for the end of the physical movement of securities certificates in connection with the settlement of transactions among brokers and dealers." Egon Guttman, Transfer of Securities: State and Federal Interaction, 12 Cardozo L. Rev. 437, 447 (1990); accord S. REP. NO. 94-75 at 5 (1975) ("A national clearance and settlement system is clearly needed."). To comply, "[b]rokerages and banks created [depositories] to allow them to deposit certificates centrally (so-called 'jumbo certificates, ' often representing tens or hundreds of thousands of shares) and leave them at rest." Larry T. Garvin, The Changed (And Changing?) Uniform Commercial Code, 26 Fla. St. U. L. Rev. 285, 315 (1999).
In 1973, just after the paperwork crisis and with the federal writing on the wall, the members of the New York Stock Exchange created DTC to serve as a depository and clearing agency. Originally there were three regional depositories in addition to DTC: the Midwest Securities Depository Trust Company, which held through its nominee, Kray & Co.; the Pacific Securities Depository Trust Company, which held through its nominee, Pacific & Co; and the Philadelphia Depository Trust Company, which held through its nominee, Philadep & Co. "[I]n the 1990's DTC . . . assumed the activities of the [other] depositories." Carnell & Hanks, supra, at 26. Today DTC is the world's largest securities depository and the only domestic depository. Kahan & Rock, supra, at 1238 n.50. "DTC is owned by its 'participants, ' which are the member organizations of the various national stock exchanges (e.g., State Street Bank, Merrill Lynch, Goldman Sachs & Co.)." Street Name at 10-6 to 10-7.
DTC has been estimated to hold "about three-quarters of [the] shares in publicly traded companies." Garvin, supra, at 315; accord Kahan & Rock, supra, at 1236; Street Name at 10-4 n.2. "The shares of each company held by DTC are typically represented by only one or more 'immobilized' jumbo stock certificates held in DTC's vaults." Street Name at 10-7. "The immobilized jumbo certificates are the direct result of Section 17A(e) of the Exchange Act, in which Congress instructed the SEC to 'use its authority . . . to end the physical movement of securities certificates . . . .'" Id. at 10-7 n.10.
The depository system is what enables public trading of securities to take place. In 2014, the NYSE reported average daily volume of approximately 1 billion shares and approximately 4 million separate trades. See NYSE Factbook, http://www.nysedata.com/factbook (last visited June 19, 2015). The failure of the certificate-based system to keep up with much lower trading volumes in the 1960s demonstrates that it cannot meet current demand. Prefatory Note at 2. Without immobilization and DTC, "implementing a system to settle securities within five business days (T), much less today's norm of T or the current goals of T or T, would simply be impossible." Kahan & Rock, supra, at 1238. Trading at current levels is only possible because of share immobilization and DTC. Street Name at 10-7; accord Garvin, supra, at 315-16; Prefatory Note at 2-3.
Because of the federal policy of share immobilization, it is now Cede-not the ultimate beneficial owner and not the DTC-participant banks and brokers-that appears on the stock ledger of a Delaware corporation. Cede is typically the largest holder on the stock ledger of most publicly traded Delaware corporations. Street Name at 10-6. To preserve the pre-immobilization status quo-at least at the federal level-the SEC provided that for purposes of federal law, the custodial banks and brokers remain the record holders. Depositories are defined as "clearing agencies." 15 U.S.C. § 78c(23)(A). The term "record holder" is defined as "any broker, dealer, voting trustee, bank, association or other entity that exercises fiduciary powers which holds securities of record in nominee name or otherwise or as a participant in a clearing agency registered pursuant to section 17A of the Act." 17 C.F.R. § 240.14c–1(i). The term "entity that exercises fiduciary powers" is similarly defined as "any entity that holds securities in nominee name or otherwise on behalf of a beneficial owner but does not include a clearing agency registered pursuant to section 17A of the Act or a broker or a dealer." Id. § 240.14c–1(c). Federal law thus looks through DTC when determining a corporation's record holders. For example, when determining whether an issuer has 500 or more record holders of a class of its equity securities such that it must register under 15 U.S.C. § 78l(g), DTC does not count as a single holder of record. Each DTC participant member counts as a holder of record. Michael K. Molitor, Will More Sunlight Fade The Pink Sheets?, 39 Ind. L. Rev. 309, 315-16 (2006) (citing SEC interpretive releases).
The federal regulations also ensure that a corporation can easily find out the identities of the banks and brokers who hold shares through DTC. Federal regulations require that DTC "furnish a securities position listing promptly to each issuer whose securities are held in the name of the clearing agency or its nominee." 17 C.F.R. § 240.17Ad–8(b). The participant listing is known colloquially as the "Cede breakdown, " and it identifies for a particular date the custodial banks and brokers that hold shares in fungible bulk as of that date along with the number of shares held. A Delaware corporation can obtain a Cede breakdown with ease. In 1981, this court noted that a Cede breakdown could be obtained in a matter of minutes. Hatleigh Corp. v. Lane Bryant, Inc., 428 A.2d 350, 354 (Del. Ch. 1981). A Cede breakdown can now be obtained through DTC's website or by calling the DTC "Proxy Services Hotline." Issuers use the Cede breakdown to understand their stockholder profile, and proxy solicitors use it when advising clients. Commentary regards the information as reliable. Handbook for the Conduct of Shareholders' Meetings 40 (ABA Business Law Section, Corporate Governance Committee ed., 2000) (identifying the "lists of holders obtained from depositories" as one of the documents that can be relied on in "determining the shares entitled to vote and tabulating the vote").
A publicly traded corporation cannot avoid going through DTC. Federal law requires that when submitting a matter for a stockholder vote, an issuer must send a broker search card at least twenty business days prior to the record date to any "broker, dealer, voting trustee, bank, association, or other entity that exercises fiduciary powers in nominee name" that the company "knows" is holding shares for beneficial owners. 17 C.F.R. § 240.14a-13(a). Rule 14a-13 provides that "[i]f the registrant's list of security holders indicates that some of its securities are registered in the name of a clearing agency registered pursuant to Section 17A of the Act (e.g., 'Cede & Co., ' nominee for Depository Trust Company), the registrant shall make appropriate inquiry of the clearing agency and thereafter of the participants in such clearing agency." Id. § 240.14a-13(a) n.1 (emphasis added). An issuer cannot look only at its own records and treat Cede as a single, monolithic owner.
B. The Funds Seek Appraisal, And DTC Certificates The Shares.
Dell was a publicly traded company and the merger involved a stockholder vote, so Dell had to go through the federally mandated process to identify the custodial banks and brokers that held its shares through DTC, then send information through them to the beneficial holders. The list of DTC-participants included JP Morgan and BONY. Through JP Morgan and BONY, information reached the Funds.
The Funds exercised appraisal rights for the 922, 975 shares that are the subject of this motion. Because they owned their shares in street name through their custodial banks, the Funds caused Cede to demand appraisal on their behalf On July 12, 2013, before the vote on the merger, Cede made appraisal demands for the Funds.
DTC held all of the Dell shares registered in street name in fungible bulk, which enabled DTC to track their ownership through electronic bookkeeping entries in the FAST Account. When the Funds caused Cede to make appraisal demands for their shares, DTC moved a corresponding number of shares out of the FAST Account by directing Dell's transfer agent to issue uniquely numbered certificates. By issuing paper certificates, DTC sought to avoid inadvertently surrendering the shares for the merger consideration along with other shares in the FAST Account. This procedure protected Dell, which effectively had "the responsibility of overseeing the surrender of shares after a merger." Ala. By-Prods., 857 A.2d at 263.
Dell's transfer agent is the American Stock Transfer & Trust Company, LLC (the "Transfer Agent"). On July 24, 2013, at DTC's request, the Transfer Agent issued paper stock certificates in Cede's name for the shares owned beneficially by the Funds
C. DTC Delivers The Certificates To The Custodians, Who Re-Title Them.
As a matter of course, DTC does not act as a custodian of paper stock certificates for its participants, even if those certificates are issued in Cede's name. A participant can pay to have a vault at DTC for its certificates, but that is a separate service. Unless a participant has arranged for a vault, DTC will contact ...