March 18, 2006
Disney Arguments in the Ovitz case
I am again late to the table, but I have just listened to the arguments before the Delaware Supreme Court in the Disney case. One: Did someone at Disney overpay Mr. Ovitz? Two: If so, should that someone be liable personally for the mistake?
Most agree that Mr. Ovitz was overpaid: $140 million for 15 months of work is too generous. [One need not get into the details: The no-fault termination agreement was so badly drafted that it gave Ovitz an incentive to quit and take his severance money and run. Disney could have chosen to fired Ovitz for fault. And so on].
The second question is the tough one. The CEO, Eisner, negotiated the agreement. Should Eisner be liable? He was not a director but only an officer. [Is negligence enough (a prudent person standard)? Or does the business judgment rule apply (protecting negligence but not gross negligence)?] The board of directors assented at some level. Should the board of Disney be liable for failure to supervise Eisner or to otherwise monitor the compensation arrangements? [Does the board have a duty to review employment contracts of this import? Does the business judgment rule apply(requiring gross negligence for liability)?]
The lawyers before the Delaware Supreme Court were there to argue law and wasted too much time arguing the facts, point one. At one point the plaintiff's counsel took the position that Eisner had lied on the witness stand and the Chancellor had not caught the lie. One defense counsel reargued the Chancellor's finding on whether Ovitz could have been terminated for cause; another spent time on risk of producing movies.
Justice Jacobs asked the critical question: When the board (or its compensation committee) is genuinely surprised by the payoff ex post how can one say the committee was adequately informed ex ante. Bingo. If Jacobs writes the opinion, Disney loses.
Unisuper v News Corp
In December of 2005 the Delaware Chancery Court decided Unisuper v New Corp, denying defendant's motion to dismiss in a claim by shareholders that a board had breached an agreement not to use a poison pill plan in exchange for the shareholders' affirmative votes on a proposal to change its place of incorporation to Delaware. The defendant board argued, citing three Delaware Supreme Court cases (Paramount, Quickturn, and Omnicare), that any such agreement is as restricting the board's inherent duty to manage the firm under Del. 141(a). Chancellor Chandler held that board agreements with third parties were distinguishable from agreements with all the shareholders and denied the motion to dismiss. The court reserved the issue of the appropriateness of agreements with some but not all of the shareholders. In reading the full opinion one sees a Chancellor working within a series of bad decision to reach the right result. The Supreme Court decisions hold that, as a matter of law, certain board contracts are void if they restrain the board's future discretion. The board in a merger agreement could not, for example, enter into deal protection provisions that stop the board from selling to a higher bidder. Of course, all contracts do this to some degree. A decision to contract to build a factory in A means that a later decision not to build is a contractual breach. At issue is the quality of the decision at the time of the contract, not whether the board is constrained financially later when it wants to change its mind and not build the factory. The Delaware Supreme Court opinions, attaching board contracts that restrict future discretion were necessarily overboard and Chancellor's opinion in News Corp is the beginning of an inevitable series of follow up opinions that limit the scope of the limitation on board contacts.
March 15, 2006
Mergers Among Securities Markets
With both Nasdaq and the NYSE now publicly traded, they both have stock they can use in acquisitions of other markets. Both markets are willing to spend to acquire and are sniffing around the purchase of the London Stock Exchange (LSE). These acquisitions will sorely test the SEC's view of monopolization in the securities markets. What is the relevant market to assess market share and thereby to assess competitive effect of such mergers? I am not confident that the SEC is up to the task and hope that Congress will start hearings on the matter before the acquisitions get to far along.
North Fork Bancorporation Payout
We have another monster payout to senior executives in a firm that has been acquired, North Fork Bancorporation. The CEO netted an estimated $135 million on the acquisition of the bank by Capital One. John Kansas will get $66 million in restricted stock, $15 in severance payments, $6 million in stock options, $4 million in stock-unites and $44 million to cover personal tax payments ( a gross up). Kansas is defending the payment as justly earned (he is 59 and has been the CEO since 1988); apparently he worked past five on occasion. Until shareholders (and the board) cease to be surprised (stunned is a better word) by such payments after the fact, I will be skeptical of the argument.
DP World Controversy Continues
The Dubai Ports World acquisition of Peninsular & Oriental Steam Navigation Co. closed in London last week. Both companies operate port terminals all over the world. DP World is controlled by the government of Dubai, one of the United Arab Emirates, and P&O is based in London.
Only ten percent or so of the P&O business is located in the United States. It operates terminals at five American ports, including New York and New Orleans. The purchase of the American operations ignited a grass-roots bushfire that enveloped Washington, D.C. Irate callers clogged the lines of radio talk show hosts and then of their congressmen.
Undeniable evidence that the controversy had gone white-hot appeared when Jay Leno disparaged the acquisition in his nightly monologue on the Tonight Show. He noted that it was like “putting Bill Clinton in charge of Hooters.”
Congress refused an offer of a forty-five day formal investigation of the national security implications of the deal. Members of Congress from both parties rushed to propose over two dozen bills aimed at halting the acquisition. After a quick 62-2 vote by a panel in the House of Representatives to block the transfer of port operations in the United States, DP World threw in the towel.
On March 9th, DP World announced that it would “transfer” its new United States operations to a “United States entity.” In other words, DP World will incorporate a United States corporation and drop the United States terminal operations into the newly created subsidiary. The United States subsidiary will either resell the assets or implement a corporate structure that isolates the assets from any management control by its parent, DP World. If DP World takes the latter tack, as it probably will with some of the terminals, Congress will find itself in the business of evaluating the merits of “Chinese wall” parent/subsidiary corporate structures.
The discontent remains. Jay Leno deadpanned in response to the DP World announcement that “the good news is that Congress forced Dubai to sell the ports… the bad news is that the sale is to Iran.”
The public learned late three salient facts about our ports: First, terminal operators do not own the ports, government port authorities do. The terminal operators lease space to run loading cranes and dock ships. Second, eighty percent of the terminals in the United States are already run by foreign-owned operators. Some of the port operators are state-owned (China and Singapore), some are publicly traded and others are privately owned by families. Third, port security is in the hands of federal customs officials and the Coast Guard, not the terminal operators. Moreover, the laborers the terminal operators must use to load and unload ships are unionized dock workers.
The dispute has also bought focus on the otherwise obscure Committee on Foreign Investment in the United States (CFIUS), an interagency group delegated with the responsibility for reporting to the President on foreign acquisitions that threaten national security. A 1988 act, known as the Exon-Florio Amendment, empowers the President to investigate and, if necessary, to block foreign acquisitions that “threaten to impart the national security.” Investigations are voluntary if the foreign-buyer is privately owned and mandatory if the foreign buyer is state-owned and the acquisition “could affect the national security.”
The President delegated investigating authority to CFIUS, which had been created in 1975. CFIUS conducts the necessary investigations and makes recommendations to the President on whether the President should block the acquisition. CFIUS is chaired by the Secretary of the Treasury and has eleven other members. It is composed of representatives of the Departments of Treasury, State, Defense, Commerce, and Justice, the Offices of the United States Trade Representative and of Management and Budget, the Council of Economic Advisors, and the Assistants to the President for Economic Policy and for National Science Affairs. CFIUS acts in confidence because it receives confidential and sensitive business information from deal participants.
The key term in the statute, “national security,” is undefined in either the statute of the CFIUS regulations. The background of the statute is in a concern over foreign acquisition of products or key technologies essential to the United States defense industry. This notion is elastic. The controversy that stimulated the 1988 Amendment, for example, was the attempted takeover of Fairchild Semiconductor Corporation in 1987 by Fujitsu, Ltd (a Japanese company). Fairchild supplied semiconductor chips to, among others, the United States defense industry. A 1992 threatened acquisition of the missile division of bankrupt LTV Corporation by Thompson-CSF, a French company, led to the 1992 Byrd-Exon Amendment that started “mandatory investigations” for state-owned company acquisitions.
In practice, CFIUS has recommended that the President block only one takeover after a formal investigation (the proposed sale of a Seattle defense contractor to a Chinese company) and has threatened to recommend that the President block four or five others. The CFIUS threat of an adverse recommendation is usually enough to stop, or modify most acquisitions; a formal report to the President is not necessary. In the DP World acquisition, CFIUS had determined initially that a mandatory forty-five day investigation was not necessary even though Dubai is state-owned. After the public outcry, CFIUS had started a formal investigation.
Some members of Congress, not content with the CFIUS procedure, have proposed legislation to give Congress a greater say in foreign acquisitions of “critical infrastructure industries,” which could include everything from water and energy companies to those involved in telecommunications or media. Such legislation has two dangers.
First, it could very quickly mix national security concerns with economic protectionism and radically change the position of the United States in the world economy. International investment is a mutual game; our companies invest abroad because foreign companies can invest here. We cannot cherry-pick those investments we want in the United States (let Honda own an Ohio automotive plant but not a trucking company, for example) without having our companies excluded abroad. Second, giving the power to Congress to, in essence, charter foreign companies, will return us to the days of the early 1800s when states chartered domestic corporations one-by-one. The result was organized graft and corruption and government-sponsored monopolies as state legislatures took payoffs to refuse charters of new companies that would compete with established ones, unless the new company could offer more.
One hopes that the cooler heads in Congress will prevail on these new bills.
March 14, 2006
New Bill on Tax-Free Spin-Off/Mergers May Pass
A bill in Congress with substantial lobbying support from investment banks would ease the restrictions on tax-free Morris trust deals. In a Morris trust deal a corporation, A, spins off a wholly-owned subsidiary, A', and then merges the subsidiary into another independent corporation, B, in a stock swap statutory merger. If the shareholders of A' own a majority of the stock in the resulting corporation the deal is tax-free. The new bill would relax the majority ownership requirement and make the technique more available in more deals. The new rule makes sense as long as the IRS can collapse deals that are disguised cash for stock payments (by, for example, A incurring debt before the deal, and dropping the debt into the sub, A', which is absorbed by B in the merger.)
Count on the French
The French have protected eleven categories of industry from cross-border mergers within the European Union. In the name of national security they have, for example, protected casinos. The Prime Minister of France, Dominique de Villepin, has made building "national champion" companies a part of his economic policy. The European Commission must decided whether to take France to court for illegally blocking takeovers. If the Commission tolerates the French policy, a tit-for-tat response can be expected from other EU countries, and the EU competitive advantage of economic unity will be in serious question.