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The prisoner’s dilemma of Bezeq shareholders

The battle over the composition of Bezeq’s board of directors, which is planned to come to a head at the shareholders’ meeting scheduled for April 26, is fascinating
Shaul Elovitch arrives at the Tel Aviv Magistrate's Court for extension of his remand in Case 4000, February 22, 2018. (Flash90)
Shaul Elovitch arrives at the Tel Aviv Magistrate's Court for extension of his remand in Case 4000, February 22, 2018. (Flash90)

The fascinating battle over the composition of Bezeq’s board of directors is a test of institutional investors’ ability to affect public companies’ governance

Not a day goes by without reading something about Bezeq. Investigations, state witnesses, litigation and more. No less fascinating is the battle over the composition of Bezeq’s board of directors, which is planned to come to a head at the shareholders’ meeting scheduled for April 26. The agenda includes appointment of external directors, independent directors and regular directors (not defined as external or independent directors). The investigations swirling around Bezeq clearly have an impact on the board election process. Not only were several board seats vacated, including seats held by the controlling shareholder’s family members, but the public shareholders were also mobilized in an unprecedented manner to take action against the company’s agenda. Each party has already taken several measures leading up to the shareholders meeting’s agenda, but there are still cards to be played.

The main players in this drama include Bezeq (and to some extent its controlling shareholder), Israeli institutional investors, the activist Elliott fund, and potential acquirers of the Bezeq Group (which apparently abandoned the acquisition in light of the board conflict).

The shareholders meeting is being convened also at the demand of Israeli institutional investors (submitted via the advisory entity, Entropy). Items on the meeting’s agenda regarding the board composition include:

  • Composition of the Bezeq Board – Bezeq’s proposal is that 13 directors may serve (three serving external directors plus two external directors elected at the meeting, two independent directors, a director designated by the employees and five regular directors). The alternative proposal presented by Bezeq as “derived from” the institutional investors’ demand is that 15 directors may serve (another external director and another regular director to be elected at the meeting). Institutional investors generally prefer small boards of directors and have claimed that their demand was misrepresented. They demand additional new external directors (three instead of two) in parallel to the dismissal of two of the incumbent external directors (scheduled to serve until the beginning of 2019). So the core of the debate is not the board’s size, but the external directors’ identity.
  • Appointment of directors who are not external directors – Bezeq proposed six regular directors, many of whom could have been eligible to be elected as external directors or independent directors, and some who even served in senior positions at Bezeq itself. In both categories, there are no alternative candidates and they may be elected simply by securing a majority of the votes cast. Bezeq’s controlling shareholder holds about 26% of Bezeq’s shares and is likely to vote for these candidates. Barring massive objection of key players to any of them, they would likely be chosen. The proposed employees’ director, who previously objected to Bezeq transactions now under investigation, is expected to receive the institutional investors’ support.
  • Appointment of external directors – the institutional investors proposed six candidates, to which Bezeq added two, so there are eight candidates for three (or two) positions (compared to a ratio of 1:1 in the other categories). The candidates also include directors with relevant qualifications and experience. Under Israeli law, external directors are elected for three years by a super-majority vote, combined of an ordinary majority of all the votes cast (including the controlling shareholder’s) and an ordinary majority of the public votes cast (excluding the controlling shareholder’s).

A shareholder who supports a specific candidate will vote for him, and to improve that candidate’s chances, the shareholder may vote against the other candidates. Therefore, Bezeq’s controlling shareholder can vote for Bezeq’s two candidates (+26%) and against the others. Thus, the other candidates are essentially starting their count from minus 26% of the votes cast and will need the support of a higher number of votes from the public to be elected. The greater the number of candidates, the greater the probability that institutional investors’ candidates will not achieve the requisite majority. Bezeq’s shares are very widely distributed among institutional investors both in Israel and around the world and the level of public participation in the vote will also be an important factor (in the prior appointment of external directors in 2017, the public participation level varied widely from one candidate to another).

Currently, all of Bezeq’s candidates for regular directors, independent directors and the employees’ director could well be appointed to their positions. The main battle is expected to be wrangled over the external directors’ appointments, and it is possible that no external director will be elected, especially not the institutional investors’ candidates. In general, controlling shareholders in public companies have a legitimate interest in being involved in the selection of external directors. Under Bezeq’s unique circumstances, the controlling shareholder could be satisfied with the preparation of the shareholders meeting by the company.

Despite the pioneering struggle of the institutional investors, they refrained from using some of the tools that were available to them. However, they still have an important card to play – the position notice. Until April 16, 2018, institutional investors may distribute to Bezeq’s shareholders and to advisory bodies (such as ISS), a proxy-type notice of their contemplated vote and the underlying reasons in its support. For example, a recommendation for a candidate with telecommunications expertise (in preparation for the anticipated changes in Bezeq) or a recommendation for a candidate who has demonstrated independence as a director. An early position notice could call on other shareholders to join the selection. If leading candidates appear, other candidates might withdraw. There will also be a debate regarding the process, which may create a similar voting pattern among shareholders, without breaching the prohibition on coordinating votes (for fear of being considered voting jointly as a block).

In the prisoner’s dilemma, due to lack of information, prisoners end up incriminating each other instead of keeping their silence and being set free. Here, too, lack of information regarding the institutional investors’ planned vote could lead to a split of the votes and to the non-appointment of the candidates these investors proposed. Each party is plotting its course independently in this tricky game. In the words of Francis Bacon, knowledge is power!

The above does not constitute legal opinion or an investment recommendation.

The writer is a Senior Partner and Head of the Mergers and Acquisitions, Securities and International Transactions Department at the law firm of Ron Gazit, Rotenberg & Co. She represented Benny Landa in his battle to improve Teva’s corporate governance.

About the Author
Ms. Herzog is Head of the Mergers and Acquisitions, Securities and International Transactions Department in the Israeli firm of Ron Gazit, Rotenberg & Co. Ms. Herzog handles a variety of Israeli and cross-border merger and acquisition transactions, for public and private companies, and private equity transactions. She advises many Israeli and foreign clients on corporate governance matters. Ms. Herzog was recommended by Legal 500 and IFLR for many years as one of the top lawyers in Israel in Corporate and M&A. She served as an Adjunct Professor of Law at Georgetown University Law Center, teaching a course on multi-jurisdictional corporate governance. She lectures on various legal matters to professional groups of lawyers. Ms. Herzog publishes numerous articles in Israel’s leading financial newspapers and is frequently interviewed in the media, on areas of her expertise. Ms. Herzog is admitted to practice in Israel and in New York. She was an associate in the Corporate and Banking department of Simpson Thacher & Bartlett in New York.
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