Business Law Prof Blog

Delaware Chancery Court and Auctions

The most interesting part of the new trilogy of opinions by Vice Chancellor Strine on private equity buyouts are his discussions on what a target board must do to secure the highest price.  In Lear the board did not violate its Revlon duties in securing the highest price and in Topps and Netsmart Technologies it did (or was likely to have, they were preliminary injunction motions).  The error in Netsmart was in not exploring a deal with "strategic buyers" as well as the private equity fund buyers.  The Judge, although asked to do so by the plaintiffs, did not fault the Special Committee's  blow- by- blow negotiating strategy with the private equity buyers, however.  Similarly in Lear, although critical of the Special Committee's specific negotiations as "far from ideal," the Judge refused say they were a violation of the board's legal duties.  Finally, in Topps, the Judge found the negotiations leading up to a merger agreement were reasonable.  The mistake the board made was the "go shop" period;  the board refused a higher bid and then refused to waive a standstill agreement with the second buyer (so it could not mount a tender offer or make public comment).  Again the court focused on structural decisions, not individual bargaining strategy, although the line was closer in the Topps case than the earlier two.  Slowly, the court is elaborating a list of "don'ts" for those negotiating private equity buyouts. 

Buyouts and the Delaware Chancery Court

The Delaware Chancery Court has issued recently three opinions critical of private equity buyouts.  They involve the buyouts of Topps Co., Lear Corp. and Netsmart Technologies.  Vice Chancellor Leo Strine Jr. wrote all three opinions.  In the Topps and Lear opinions, Chancellor Strine faulted the target companies with not providing information to their shareholders, asked to ratify the transactions, that may shield light on the incentives and motives of the company managers in recommending the deals.  In Netsmart, the Chancellor questioned whether the target company had disclosed adequately its efforts (or lack of efforts) to assess the market for other potential purchasers.  Each decision deals with the management conflicts inherent in modern private equity buyouts under the guise of adequate disclosure.  At issue will be how strongly management must word an adequate disclosure to meet the legal standards.  I am hopeful the legal standard will requirement something akin to a statement, if management is in the buyout group (or collecting a huge golden parachute payment of some form contingent on the deal), that "The managers of your company are on the opposite side of the deal being recommended and have a direct financial reward in paying you too little for your stock."       

Taxing Hedge Funds

The hearings have begun on taxing hedge fund and private equity fund "carry" as ordinary income.  The attack is based on 1) they make money, 2) they are speculators, and 3) they are instruments of change.  The is another attack on the financial speculators (gamblers who do not "make shoes") by those who under-appreciate their role in a capitalist economy.  There are other partnerships that allocate profits disproportionately to capital contributions: venture capital funds, which have a positive public image, REITS (holding land), oil and gas partnerships, and others.  Either Congress must exempt these groups, proving that it is taxing "speculators" and risk the inevitable line-drawing problems, or it must include them in the interest of tax neutrality and absorb the social costs of regulating efficient forms of capital investment that do not tie a divison of return to proportional capital contributions.  This is going to get very, very messy.

SEC Proposal on Shareholder Voting

The SEC is circulating a proposal, not yet formally proposed, to enable shareholders holding 5% or more of a public corporation's stock to put nominees for the board of directors on the corporation's proxy card.  The proposal will attract tremendous opposition from both company managements, who support current practice, and from shareholders, who believe the 5% requirement is too high.  The opposition will probably cow the SEC into doing nothing. 

The SEC approach is a further erosion of its "disclosure only" theory of regulation and a logic step from Rule 14a-8, a rule that requires firms to put specified items requested by shareholders on their proxy cards.  The further the SEC steps away from its "disclosure" regulation role the more it displaces state corporate codes control over corporate structure.  Some steps at the federal level seem to inevitably turn into to larger steps. 

In any event, the way out the SEC's conundrum, is to feature choice not mandatory rule.  Publicly-traded corporations could be asked to themselves produce a shareholder voting system that shareholders would have to ratify every five (three??) years or so. Shareholders could submit their own amendments at the ratification vote.  Some corporations could opt for 5 year board elections, others for 1 year elections with liberal nominations.  Supermajority requirements should require a supermajority ratification vote.  A robust system of choice could include modifications of shareholder derivative litigation rules or the choice could be limited to voting procedures.  Choice would blunt the criticism of both management and shareholder groups to the current proposal and leave the rule to a shareholder vote.       

Midwest Air Group Takeover

The refusal of the board of Midwest Air Group to sell to AirTran Holdings for $400 million, despite the overwhelming support of Midwest shareholders, is a classic illustration of the power of constituency statutes.  Midwest is incorporated in Wisconsin, a state that by legislation empowers corporate boards to look after constituencies other that shareholders (read employees).  The Midwest board used the statute to justify the rejection of the bid.  Midwest shareholders are now voting the board out, one election at a time (it will take two years; the shareholders elect only one-third of the board a year).  The CEO of Midwest, with a healthy yearly salary, has only a modest golden parachute in place.  Look for a bigger payout (a "consulting contract") and a deal.  Constituency statutes do not help non-shareholder groups, other than senior excutives of course.

Milberg Weiss's Woes

David J. Bershad, a former partner with the nation's leading plaintiff securities firm for over twenty years (now split into two firms), has pleaded guilty to a 20 count indictment detailing illegal kickbacks to named plaintiffs in the firm's lawsuits.  He has also agreed to cooperate with federal prosecutors in providing information that may be used against other high profile partners (William S. Lerach and Melvyn I. Weiss may be probable targets).  This is bad stuff, despoiling the name of lawyers, which needs no further rotting.  Folks in industry (and their lawyers) often suspected that the named shareholders where paid puppets of the plaintiff's lawyers but they could not prove it.  The government has (using a deal with one of the paid named plaintiffs would had other criminal troubles and agreed to sing). [I cannot get over the hubris of using the same named plaintiff in 150 or so suits! Did the lawyers think no one would notice???]  This is the big break in the case -- the facts are now out and confirmed; the prosecutors will now play out the string on the remaining targets.

The case is largely historical due to a change made in 1995 by Congress that permits large shareholders to take over securities class action cases brought by smaller ones.  The new larger plaintiffs often bring their own lawyers.  There is still an incentive to find (bribe) a small shareholder to bring the case and stimulate larger shareholder to take the case, but the incentive to bribe a smaller shareholder to sue initially is diluted substantially.  A final salutary change would be a minimum shareholder stake requirement for private litigation that is small (.01% in stock or $25,000 in value, whichever is less) but large enough to discourage the practice of holding one share in 500 companies or so solely to be available to plaintiff's firms as a named plaintiff.