On Fiduciary Duties: Why Apple Hasn’t Lost its Mojo


February 8, 2013 (11:30 pm)

For those who haven’t been a member of a company’s board of directors and haven’t been to business school (or, for that matter, been an investment banker who deals with boards constantly), we thought it would be important to discuss the role of a public company’s board of directors. This is, of course, directly related to the investor reaction of the memo released by Apple’s Board of Directors yesterday. Clearly this had an immediate and significant impact on the share price.

EINHORN: First, what happened yesterday? David Einhorn, a prominent Apple shareholder, made the rounds on business news networks to discuss his proposal to unlock the value of Apple’s enormous cash hoard. His hedge fund (Greenlight Capital) is suing Apple in a New York federal court over the company’s proposal to eliminate preferred stock. At a very high level, he’s proposing for Apple to issue perpetual preferred stock with a 4% dividend yield. But his actual proposal is less important than the fact that he’s so publicly pushing for the Board to do something with their cash. And even more important was his disclosure that Apple is having active discussions with large shareholders on returning that cash.

BOARD RESPONSE: Einhorn’s comments yesterday morning got the stock moving, if only briefly. The stock was up, but lost its gains throughout the session. But then 30 minutes before the close, Apple’s Board of Directors issued a press release.

“We find ourselves in the fortunate position of continuing to generate large amounts of cash, including $23 billion in cash flow from operations in the last quarter alone.

Apple’s management team and Board of Directors have been in active discussions about returning additional cash to shareholders. As part of our review, we will thoroughly evaluate Greenlight Capital’s current proposal to issue some form of preferred stock. We welcome Greenlight’s views and the views of all of our shareholders.”

After this announcement, the shares skyrocketed $15 in minutes and closed at the highs of the day. But was this response warranted?

FIDUCIARY DUTIES: Under the corporate law of most states (including California) directors must discharge two primary fiduciary duties. Board members care about acting in good faith, and discharging their duties responsibly, because shareholders can sue directors for breach of fiduciary duties and hold them personally liable for damages to the corporation.

  • The Duty of Care: Requires directors to make a business decision based on all available and material information. The board must act in good faith for the company’s best interest and must believe that the actions promote the best interest of the company based on a reasonable investigation of the options available. If directors act in good faith and as a reasonable person would have acted, they will not be held liable for unfavorable outcomes.
  • The Duty of Loyalty: Imposes on the board a duty to protect the interests of the corporation and an obligation to refrain from conduct which would injure the corporation and its shareholders. Directors must avoid any conflict between duty and self-interest. Full allegiance to the corporation’s best interest is required (over the board members’ own interests).

EVALUATION: The duty of care applies here. The board has a duty to evaluate all available options when it comes to promoting the best interest of the company and its shareholders. Does the company have a reasonable use for $137 billion in cash and marketable securities (likely higher now that we’re six weeks into the new quarter)? Would returning a larger share of that cash promote the best interest of shareholders? Think about the fact that Apple generated $40 billion in free cash flow (after all expenses, R&D, capital expenditures, etc.) in calendar year 2012 alone. If they had zero dollars in the bank on January 1, 2012, they would have ended it with over $40 billion. Why do you need $137 billion in the bank if you expect to generate an additional tens of billions each year?

These are all questions that Apple’s Board must constantly assess and evaluate. It doesn’t necessarily mean that they must distribute this cash back to shareholders. But it is completely unreasonable for investors to expect that the Board does not constantly evaluate this.

INVESTOR EXPECTATIONS: So as investors, we all must reasonably expect that Apple’s Board is constantly evaluating the distribution of additional cash back to shareholders. The Board said last year (when they initiated a dividend) that the company has more cash than it needed. If that was the case then, when they reported $97 billion in cash and marketable securities, how could they NOT be looking at ways to return additional cash to shareholders? We view the Board’s press release as old news.

There’s nothing we didn’t know. “We find ourselves in the fortunate position of continuing to generate large amounts of cash.” Yes, we already know that. “As part of our review, we will thoroughly evaluate Greenlight Capital’s current proposal.” That’s not surprising, given the Board’s duty of care to evaluate available options to promote the best interests of the company and its shareholders. We’ve “been in active discussions about returning additional cash to shareholders” is the only meaningful sentence. However, given the fact that they described last year’s $97 billion as more than they needed, returning additional cash is to be expected. So what’s the deal?

MOMENTUM: It’s clear that Apple is not a “dead” stock, as many have mentioned. It’s been trashed and tarnished, with bears coming out of the wood works. But at any hint of good news, you see a rush of momentum into the name. While that momentum has been sold into during the entire four-month correction, what it makes crystal clear is this. There are an enormous number of investors and traders that are sitting on the sidelines just waiting to get back into Apple. Whether it be a fundamental reason, or a momentum play, we’re very likely to see a reason (any reason, really) for them to jump back in. It may not be this week or next. But it’s coming.