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Photographer: David Paul Morris/Bloomberg.

Mark Zuckerberg Signed the Wrong Document

Matt Levine is a Bloomberg View columnist. He was an editor of Dealbreaker, an investment banker at Goldman Sachs, a mergers and acquisitions lawyer at Wachtell, Lipton, Rosen & Katz and a clerk for the U.S. Court of Appeals for the Third Circuit.
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A problem at the very top of corporate management is, if you don't have a boss, who decides how much you get paid? I mean, it's not a problem for you. You decide how much you get paid. Be generous! But it's a problem for that boss you don't have. Corporate directors work for the shareholders, but the shareholders are mostly not around to supervise them. So directors tend to decide for themselves how much they get paid, which leads some shareholders to worry that they get paid too much.

Here's what happened at Facebook. Facebook had eight directors on its board. Six of them were not Facebook employees. Two of them were: chief operating officer Sheryl Sandberg and Mark Zuckerberg. Zuckerberg is of course Facebook's co-founder, chief executive officer and board chairman. He is also its majority shareholder, sort of: Facebook has two classes of stock, with Class B shares getting 10 votes per share, and Zuckerberg owns most of Class B, so he controls about 60 percent of the vote despite only owning about 15 percent of the stock.  In 2013, the board met to decide how much to pay itself, or, rather, how much to pay the six non-employee directors. (Sandberg and Zuckerberg, as employees, had separate arrangements. ) The directors decided to pay themselves about $300,000 a year, in the form of restricted stock units, plus various committee fees and other amounts. Later, a formal plan was circulated, and all of the directors approved it by written consent.

Then a shareholder sued, claiming that the directors were paying themselves too much. Which is a thing you can sue for! Sort of. The rule is, roughly speaking:

  • If the directors just decided how much to pay themselves, you can sue, and a court will look into whether what they paid themselves was fair.
  • But if a majority of the shareholders signed off on what the directors get paid, you can't sue, because, you know, the bosses approved the pay package.

Now of course, Mark Zuckerberg is a majority of the shareholders, for these purposes. And of course he signed off on the pay package: He was at the board meeting that discussed it, and he signed a written consent approving it. So you might think that would be enough? But no! He signed off on the pay package as a director. He didn't sign off on it as a shareholder. He signed, but on, like, the wrong letterhead.

Actually he signed off on it as a shareholder too, but only after the lawsuit started: 

Zuckerberg filed an affidavit in support of the summary judgment motion declaring as follows:

10. Regardless of the capacity in which I have considered the issue, my view of the compensation of Facebook’s Non-Executive Directors has never changed. I approve of all 2013 equity awards to Facebook’s Non-Executive Directors, as well as Facebook’s plan for compensation of Non-Executive Directors going forward (pursuant to the Annual Compensation Program). . . .

11. Although I was never presented with an opportunity to approve formally the 2013 equity awards to Facebook’s Non-Executive Directors or the Annual Compensation Program in my capacity as a Facebook stockholder, had an opportunity presented itself, I would have done so. If put to a vote, I would vote in favor of the 2013 equity awards to Facebook’s Non-Executive Directors, as well as the Annual Compensation Program, and if presented with a stockholder written consent approving them, I would sign it.

Too late though! And still on the wrong letterhead. In a 38-page opinion, the Delaware Chancery Court decided that "Zuckerberg did not make use of a formal method of expressing stockholder assent," and therefore it didn't count. Delaware corporate law has a formal process for stockholders to give their written consent to corporate actions, and Zuckerberg didn't follow it, so he didn't successfully approve the pay packages

Once the statutory framework is removed, the possibilities for ambiguity in expressing approval are seemingly limitless—if affidavits are sufficient, what about meeting minutes, press releases, conversations with directors, or even “Liking” a Facebook post of a proposed corporate action? Such an approach would require directors, stockholders, and courts to engage in the inefficient exercise of divining the intentions of a controlling stockholder, and would cut away at the certainty and precision that make the formalities of stockholder meetings or statutorily compliant written consents beneficial.

Imagine Liking a Facebook post of a proposed corporate action. But, sure. Now Facebook needs to prove in court that its directors' pay is "entirely fair," which seems like kind of a bizarre thing to prove.

Of course this is colossally silly. But you can kind of see what it's driving at. Facebook sure looks like Zuckerberg's company. He founded it. He runs it. He controls the stock. He picks the directors. When Facebook went public, he wrote shareholders a letter saying that he would keep running Facebook his way. "We think it’s important that everyone who invests in Facebook understands what this mission means to us, how we make decisions and why we do the things we do," he said. The implication was: And we're not going to change how we make decisions just because we have some new shareholders.

The law does not especially see it that way. From the opinion:

It is therefore of no moment that Zuckerberg undisputedly controls Facebook. Although he can outvote all other stockholders and thus has the power to effect any stockholder action he chooses, he still must adhere to corporate formalities (and his fiduciary obligations) when doing so, because his rights as a stockholder are no greater than the rights of any other stockholder—he simply holds more voting power.

"His rights as a stockholder are no greater than the rights of any other stockholder." Zuckerberg might -- quite reasonably! -- see Facebook as his company, which just happens to have raised some money from outside investors. (Which has worked out well for those investors.) But the law sees him as just another shareholder, whose large shareholdings and job as CEO are coincidental, whose control of the company can be measured purely by numbers and without reference to his personal relationships and history.

Today the Information had an article about supervoting shares at big private tech companies. There are ... kind of a lot of them? Theranos has "a supervoting share structure that gives insiders 100 votes per share," and Uber, Airbnb, Palantir, Dropbox, WeWork, Square, Snapchat and SpaceX all have two (or more) classes of shares with different voting rights. A lawyer says: "You’re sending a very clear message to (investors) whether you intend to or not: You can consult with me, but I’ll listen to you if and when I decide to listen to you, and that’s it." You can see why founders would like sending that message. The founders identify themselves with their companies, and for companies like Uber and Square and SpaceX, investors identify them with their companies too. These startups are extensions of their founders in a way that public companies are not, and that public markets are not comfortable with.

Elsewhere, the Financial Times's Lex column has a dire message for tech unicorns: "If you are a privately owned technology company with a valuation in excess of $1bn and were thinking of going public, do not."

Public markets are nasty, brutish and full of shorts. The unicorns can always find a way for employees and early investors to sell their shares privately. They should stay off the stock markets forever. 

Add to that list that public markets are full of people who will sue you for approving your directors' compensation on the wrong letterhead. It's quite a disincentive to go public!

I think a lot about how modern finance is changing and customizing what it means to "own" a company, and how companies interact with their shareholders. There is a standard set of rules -- public listings, free transferability, shareholder democracy, corporate formalities, fiduciary duties of directors to shareholders -- that have worked pretty well for a pretty long time, and that have become a pretty strong default expectation. But they're not as necessary as they used to be. There is a longer tail of financing opportunities; you can fund yourself on Kickstarter, or you can raise billions of dollars from mutual funds without ever technically "going public." Lex is right: Private companies really "can always find a way for employees and early investors to sell their shares privately," and there are private exchanges to facilitate those sales on terms approved by the companies, so that those shares don't fall into the hands of activists or short sellers or high-frequency traders. Supervoting stock can avoid shareholder democracy, and even fiduciary duties to shareholders are no longer universally required. Probably the blockchain will do something to revolutionize corporate ownership, why not.

I tend to think that these innovations are cool. Different companies might well want different financing and governance and liquidity structures, and voluntary experiments among consenting adults should be encouraged. If founders want dual-class stock and smart venture capitalists want to give it to them, go right ahead. But the public markets are for everyone, and not everyone is a consenting adult. The public markets are full of widows and orphans who expect the default structures of ownership. They are also full of plaintiffs' lawyers who enforce those structures. If you are a unicorn with your own ideas of how you should relate to your shareholders, the public markets may not be a welcoming place.

  1. This action took place in 2013. Facebook still has eight directors, but now three -- Zuckerberg, Sandberg and Jan Koum, the co-founder and CEO of WhatsApp -- are also employees.

  2. He owns stock with 53.9 percent of the vote, but he has a proxy on some shares owned by Dustin Moskovitz that get him up to 60.1 percent. In 2013, when this happened, he "controlled over 61% of the voting power," according to the Chancery Court opinion.

  3. Zuckerberg gets paid a dollar because he is comically rich. Sandberg's reported total compensation was $16.1 million in 2013.

  4. The actual rule is more boring. From the opinion:

    Directors are necessarily interested in their compensation, which is a benefit they receive that does not accrue to stockholders generally. Thus, where, as here, directors make decisions about their own compensation, those decisions presumptively will be reviewed as self-dealing transactions under the entire fairness standard rather than under the business judgment rule. A decision dominated by interested directors can gain the protection of the business judgment rule, however, if a fully-informed disinterested majority of stockholders ratifies the transaction. At that point, the doctrinal standard of review becomes one of waste.

    So if shareholders don't approve, the test is "entire fairness," in which the directors have "to show that the amounts they awarded themselves are entirely fair."

    If the shareholders do approve, the test is "waste," a delightful technical term in Delaware law: You can sue board for wasting corporate assets. But "the test for waste is extreme and rarely satisfied," and "allegations that compensation is 'excessive or even lavish, as pleaded here, are insufficient as a matter of law to meet the standard required for a claim of waste.'"

    Oh, one other thing: Notice the words "fully-informed disinterested majority." Even if Zuckerberg had formally voted for the pay packages, shareholders could have claimed that he wasn't fully informed or disinterested in his vote, and then Facebook would have had to litigate that. Delaware corporate law is written for lawyers.

  5. I know, it's not a majority of the shareholders, it's a majority of the shares. I mean he is just one guy. "Majority of the shareholders" sounds better though.

  6. As a shareholder! There is also a formal process for directors to give their consent, and he did follow that, so he did approve the pay package, as a director.

  7. As he said in a deposition in this case: "These are the people who I want and – and who I think will serve the company best."

  8. In fact they are less. If I owned 100 shares of Facebook stock, I could vote them however I wanted to. But because Zuckerberg is a controlling shareholder, he has fiduciary duties to other shareholders. This is part of why the court cared about the formalities:

    Failing to adhere to corporate formalities to effect stockholder ratification also impinges on the rights of minority stockholders. In traditional agency relationships, a single principal’s ratification of an agent’s conduct comes at a cost to that principal only. But in the corporate context, the ratification decisions of a controlling stockholder affect the minority stockholders. Although minority stockholders have no power to alter a controlling stockholder’s binding decisions absent a fiduciary breach, they are entitled to the benefits of the formalities imposed by the DGCL, including prompt notification under Section 228(e). This requirement promotes transparency and enables minority stockholders to stay abreast of corporate decision-making and maintain the accountability of boards of directors and controlling stockholders.

  9. I should say, nothing in the actual court opinion here has anything to do with public markets: It's a decision of Delaware corporate law, applicable to public and private companies alike. But! The thing is, if Facebook was still private and controlled by its founder and a handful of venture capital firms, no one would have sued. It is not the law that is a feature of being a public company; it's the litigious shareholders.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

To contact the author of this story:
Matt Levine at mlevine51@bloomberg.net

To contact the editor responsible for this story:
Zara Kessler at zkessler@bloomberg.net