Business Law Prof Blog

SEC Commission Glassman Gets Real

In a speech given Nov. 17  in Denmark, SEC Commissioner Glassman admitted the obvious:  Section 404 of Sarbanes Oxley and the SEC's rules under the section are not working.  Section 404 requires publicly traded companies in the United State to put in a system of internal controls and requires that auditors include a verification of the internal controls in their audits.  Glassman noted:  "What was intended to be  top-down, risk-based management exercise has become a bottom-up, non-risk based process with an apparent focus on controls for controls sake."  She noted that the expenses of complying with the Section were "excessive." 

Congress and the SEC have, from the beginning, shown an amazing lack of common sense over these mandated internal controls.  Congress first threatens auditors with huge personal liability and with losing their firms and their jobs and then gives auditors an open-ended requirement to certify companies "reasonable" internal controls.  And auditors are risk averse by nature anyway.  The auditors did what any extremely risk averse profession would do; they had professional to standardize and develop complex check-lists of tasks.  They would hide in group behavior and in detail.  They could not be liable if the did what others auditors did and they did it in great detail.  Then the auditors forced all companies to submit to the check-lists.  Their behavior was to be expected.  The SEC's response was to jawbone -- yell at auditors for being too inflexible -- and lash out at critics, reminding them that the 33 act was criticized too as too expensive.  The SEC response was silly: It has not worked of course.  Either the SEC gets more specific in the rules (which it does not want to do) or it relaxes the tremendous liability pressure put on auditors who implement the rules.   

Texas Genco Deal: Shaping Up Government

  Four private equity firms bought a small electricity company in Texas, Texas Genco, for $900 million last year and sold it this year for $5.8 billion, for a profit of $4.9 billion.  The reason?  They found a hole in the Texas electrical utility law.  The law pegs electricity prices to the price of natural gas, which is skyrocketing, and Genco produces electricity with coal and nuclear power.  The result is that Genco can show shocking profits and the investors sold the company based on the profits.  Smart hedge funds and private equity firms have shown great ability in exploiting silly government regulation to make big money.  The Genco investors were smart enough to demonstrate the loop-hole and smarter still to sell the company to others before the Texas government moves in to close it.  Hedge funds and private equity firms are not only going to shape up management of languishing firms, they are going to shape up government.  Government officials are going to have to work harder to stay up with these folks.      

Sovereign/Santander Deal Amended; NYSE Signs-Off

Posted by Bill Sjostrom

As I discussed in this post, Sovereign Bancorp's largest shareholder, Relational Investors, had asked the New York Stock Exchange to require Sovereign to put the sale of a 19.8% stake to Spanish bank Santander to a vote of Sovereign shareholders.  In a press release yesterday (click here), Sovereign reported that following some changes to the deal with Satander, the NYSE will not be requiring a shareholder vote.  According to the press release, these changes include the following:

-The elimination of both Santander’s veto with respect to the termination of Sovereign’s chief executive officer and the requirement that any new chief executive officer be reasonably acceptable to Santander.
-The elimination of Santander’s obligation to vote its Sovereign shares in favor of Sovereign’s board nominees.
-The addition of a fiduciary out to provisions in the Agreement that prohibit Sovereign during the pre-closing period from responding to acquisition proposals from third parties and a $200 million termination fee payable to Santander if Santander elects to terminate the Investment Agreement as the result of Sovereign entering into an acquisition agreement with a third party.
-The elimination of provisions providing for the continuation on the Sovereign board of directors of Sovereign’s directors in office at the time of any future acquisition of Sovereign by Santander for an additional 10-year period.

This article indicates that Relational and other institutional investors are considering an appeal to the SEC, although its unclear on what grounds.  If these investors really believe, as this Reuters article reports, that "Sovereign designed the three-way deal to dilute their voting power, entrench CEO Sidhu and other management and directors, and fend off a proxy fight,"  why aren't they pursuing a breach of duty of loyalty claim in state court? 

Ellison Settles

A San Mateo Superior Court Judge approved the settlement of a derivative action filed in California against Larry Ellison, CEO of Oracle, Inc..  Story  The suit claim that Ellison engaged in insider trading when he sold $900 million of Oracle stock in 2001 shortly before the company issued an earnings warning.  In the settlement Ellison agreed to give $100 million to charity and to pay $22 million to the plaintiff's lawyers.  Astute observers will note that the Judge refused the first settlement agreement because Oracle was to pay the plaintiff's lawyers rather than Ellison.  Joseph Tabacco, a lead attorney for the plaintiff called it an "extraordinary result and.. one that is of great benefit to Oracle."  I agree with him on the first claim but not the second.  Oracle and its shareholders get nothing.  The Judge was responsible for making sure that the plaintiffs agreement to settle is in the best interests of the Oracle shareholders.  Only if the suit had a very marginal chance of success should such a settlement have been finalized.  Is this what the judge decided?   A class action suit, based on federal securities law violations, is still pending in federal court.

Why So Few Negotiated Tender Offers? Fear Of Rule 14d-10

The widespread use of takeover defenses by American companies has an obvious side effect:  To takeover an American company a bidder must usually make inducement payments to the target senior managers (the executive directors).   Executive directors enjoy lucrative payouts from golden parachute severance packages, non-compete agreements and consulting contracts.  The federal courts have ruled that when the payments are too bald, that is, that they are obvious side-payments for the executive director's stock, the payments may violate Rule 14d-10.  The Rule requires that in tender offers, the bidder makes the same offer to all the shareholders in the targeted class of stock. 

The Courts held that the side-payments meant that the executive directors were getting more than other shareholders for their stock.  The result of the court rulings has been that lawyers are recommending to target clients that there use mergers rather than tender offers to close negotiated deals.  The mergers take significantly longer to close, often require a more shareholder meetings, grant more dissenters appraisal rights, involve more pricing risk, and give competitors more time to break up a negotiated deal.  So compensation concerns are driving the form of many negotiated deals to the detriment of the companies involved perhaps. 

Lawyers have asked the SEC to clarify the Rule and we are still waiting on the SEC's response.  Some lawyers fears seem overblown.  Severance packages put in well in advance of the deal and not involving the bidder are safe as are respectable employment contracts of a target officer by the bidder after the deal.  Only those side-payment deals negotiated on the eve of or during a pending tender offer and directly involving the bidder are suspect in most courts... 

The practice of bidders paying executive directors of a target for the privilege of negotiating a friendly deal in an unfortunate custom, grown out of the use and sanction of takeover defenses.  It is now out of hand as the practice now dictates the core form of some deals.  The Courts are on the right track but having trouble with a rule not designed specifically to the practice.  Severance packages as part of an employment agreement are not a problem, unless the bidder is involved in their creation.  Non-compete,consulting, and other employment contracts between bidders and target executives can be legitimate but are easily abused as sham transactions. They present old fashioned duty of loyalty problems.  The state courts are the proper forum for these claims and should use a traditional duty of loyalty analysis.   

Securities Exchanges as Publicly-Traded Corporations

  Three securities exchanges have gone public this year:  The Chicago Board of Trade (CBOE), the International Securities Exchange (ISE), and recently the Intercontinential Exchange (ICE).  The Chicago Mercantile Exchange (Merc) went public in 2002.  The exchanges all deal in financial derivatives:  CBOE trades treasury treasury futures, the ISE features stock options, the ICE trades energy contracts, and the Merc features Eurodollar futures.  Each has been a success story.  The Merc went public at $35 a share and is now trading at over $375.  The ISE, is up two-thirds since a debut in March of this year.  ICE opened at $26 a share and climbed to $40 on its opening day.  These are stunning numbers and suggest that when our stock exchanges go public we will see some remarkable valuation numbers.  Are the prices a bubble or real?  I believe that they are real with market insiders reflecting two things:  First, exchanges will be run very differently once they de-mutualize (not longer a member run old boy's club, they will have to show profits) and, second, the exchanges have a very privileged regulatory position, giving them pricing power in their markets (profits are available to be made by the new managers).  When the NYSE goes public in its reverse merger with Archipelago, we are going to see some real fireworks.

Revised J&J/Guidant Merger Agreement

Posted by Bill Sjostrom

The Amended and Restated Agreement and Plan of Merger for the J&J/Gudiant deal is now available on the SEC’s website (click here).  I took a quick look at this new agreement and noted the following:

•    The exchange ratio for the conversion of GDT stock into JNJ stock is now fixed at .493 per share.  The original agreement provided for a formula based conversion ratio (discussed in this earlier post).
•    The cash portion of the deal has been upped from $30.50 to $33.25 per share.
•    The termination fee applicable to JNJ has been reduced from $700 million to $300 million.
•    The termination fee applicable to GDT has been reduced from $750 million to $625 million.
•    Very little was added to the agreement to address the developments leading to the revised deal.  It looks as if none of GDT’s representations and warranties were changed.  However, they are now all subject to anything disclosed in GDT’s SEC filings prior to 11/14/05 (the date the revised deal was executed) and supplemental disclosure provided to JNJ by GDT since execution of the original agreement.