February 15, 2007
Professor Subramanian on Staggered Boards
Professor Subramanian notes in a recent editorial to the Wall Street Journal that staggered boards are slowly being eliminated under pressure by shareholder advocacy groups. He recommends that staggered boards be moved to the bylaws from the articles of incorporation as a "best of both worlds" solution. The board can be staggered to minimize elections but shareholders can amend the bylaws to eliminate and replace a staggered board in a single year in takeover situations. Of interest to his claim, however, is the new popularity of two-tier voting stock in IPOs however. Google and now Fortress are two of many, many examples. One does not need a staggered board to defend against takeovers when the votes are concentrated in a Class B stock held solely by the founders.
Professor Grunfest on Securities Class Actions
Professor Grunfest of Stanford has an editorial in the Wall Street Journal noting the surprising falloff in securities class actions filings since 2005. He argues that the best explanation for the decline in filings is that, in response to Sarbanes-Oxley perhaps, managers are behaving better. He dismisses as not "holding water" my view, expressed in an earlier blog, that the difficulties of the country's two largest plaintiff law firms, once joined, are to blame. Milberg Weiss & Bershad split with Lerach, Coughlin et al. a few years ago. When joined the firms filed over 60 percent of the country's class action suits and apart the two firms combined continued to dominate the market with similar numbers. Cooperman, a named plaintiff in over 70 lawsuits by the firms, pled guilty to accepting kickbacks of over $6.4 million. Two lawyers in Milberg have been indicted and there is speculation on whether Milberg and Lerach, the two founders are under investigation. The charges have caused both firms to lose clients and to lose partners and associates. Professor Grunfest argues that there are many more plaintiff's firms out there ready to take over whatever cases could be brought. I think he overlooks the barriers to entry in the business. Plaintiff firms have to be very-well financed and very-well staffed; they take substantial risks on a portfolio of cases, carrying the costs of each, and hoping that some will come in and pay for those that do not. This is not for the faint of heart. The firms also must have reputations for success that attract shareholders who are willing to named plaintiffs. Bankrolling the very largest cases, against multiple determined and well represented opponents, is not something any small plaintiff's firm can do. I think he underestimates the difficulty of starting and maintaining a successfully law firm that does the very largest cases. New firms will emerge but it will take time, and we will see the class actions come back. As evidence for my position, I note that the earnings restatements are down only slightly but that the percentage of earnings restatements that have immediately stimulated securities class actions seems to have declined (my data is anecdotal however)
Delaware Chancery Court on BackDated and Spring Loaded Stock Options
The Delaware Chancery Court, in two opinions, In re Tyson Foods and Ryan v Gifford, ruled against motions to dismiss in derivative actions based on improperly granted compensatory stock options. In Tyson Foods the claims was based on spring-loaded options (options granted on the eve of known good news); in Ryan v Gifford the claim was based on back-dated stock options (options back-dated to an earlier grant date so as to fix a lower exercise price equal to a lower stock market price). In both the Court held the a demand on the board excused and in both the Court noted that the claims stated an allegation of board "bad faith" and breaches of the duty of loyalty. The decision on the spring-loaded options is particularly notable because the SEC, although uncomfortable with the practice, has apparently decided that the options are not a version of illegal insider trading under Rule 10b-5. The use of "bad faith" as the defining doctrine is notable as well; the Court may be giving life and shape to the Disney ruling that identified the lack of bad faith as a separate duty of the board of directors (although the Court did freely use duty of loyalty language as well). The Chancery Court held that spring loading was potentially deceptive to shareholders and needed express shareholder approval. Both rulings should encourage shareholders to bring derivative actions against the 200 or so companies accursed of improperly granting compensatory options.
There are only twenty or so pending class action lawsuits in federal court arguing that back dating options is a violation of federal securities laws. The federal suits are limited by the need of shareholders to show damage to the value of their shares; when the illegal practice is disclosed the stock prices of many firms have not declined significantly. The state derivative actions are not so limited and may simply demand that executives cancel the options and otherwise pay damages suffered by the firm itself. These two rulings should stimulate a wave of private derivative litigation. Even litigants worried about statute of limitations issues (most of the practices happened form 1998 to 2002) should take solace in the Tyson ruling, which held the statute tolled by "fraudulent concealment."
Delaware Chancery Court Halts Caremark Vote
The Delaware Chancery Court has ordered that Caremark postpone its vote to approve a merger transaction with CVS. Another bidder, Express Scrips, had offered a higher bid. After the court decision, CVS increased its offer. The Court held that Caremark had not given shareholders enough information on the competing bids. Three proxy advisory firms, including ISS, had recommended that Caremark shareholder vote down the merger. The negative recommendations were based on the Caremark board's bias in the bidding for the CVS offer and hostility towards the Express Scrips offer. The advisory firms believed that Caremark could sell for more in a continuing auction. Express Scrips is waiting on an FTC decision on whether to issue a "second request" under Hart-Scott-Rodino for more information on potential antitrust problems in its propose acquisition of Caremark. The Court's intervention before the vote is unusual, particularly in light of the proxy advisory firm negative recommendations. In any event, it appears that the Delaware Chancery Court is willing to assume a role of referee in contested acquisitions and will blow the whistle on acts of the target that favor to much one side over the other.
February 12, 2007
Business schools are focusing on teaching "soft" people skills to potential business leaders. Law schools are not far behind. Having read a serious of biographies of great business leaders at the turn of the century recently (Frick,; Carnegie, Ford, J.P. Morgan, Rockefeller), I cannot but help observe that it was not "soft" people skills that made them leaders. Many were tough nuts. What all had, however, was discernment at critical points, and strong commitment and drive. How does one teach discernment (judgment)??
Fortress Investment Group IPO
The Fortress Investment Group IPO was a hot issue. Investors drove up prices 68 percent on the first day of trading. The offering is unique because it is the first in American markets of a hedge fund manager. It reminds me of the Google offering in that only a small fraction of the equity is being sold in the IPO (less than nine percent) and the voting stock (Class B shares) is not being sold at all. Only Class A shares have been sold in the IPO. The five principals of the firm will own 78 percent of the total common (Class A and Class B) and 100 percent of the voting common (Class B stock) after the offering. There is no takeover premium in the stock sold. Investors seems quite content to make permanent bets on existing management. If managers leave voluntarily they sacrifice Class B shares, forcing them to exercise their right to convert to Class A. Twenty or thirty years out, an eternity for the markets, the firm will be faced with a need to change management and no easy way to do it. Look at the New York Times.
Phelps on Entrepreneurial Culture
Edmund S. Phelps, a Nobel prize winner in economics, has written a series of editorials in the Wall Street Journal about the determinants of a country's "entrepreneurial culture." Todays paper contains another. He has made the point the the United States is a healthier economic system than those in other developed countries, particularly those in Europe. Studying the performance of the "Big Three", Germany, France, and Italy, he notes that they lag significantly behind the United States in unemployment rates, labor force participation rates, productivity, and, surprisingly, in employee engagement and job satisfaction surveys. He takes the differences and attempts to correlate them to a country's characteristics. He finds that a country's economic institutions and economic culture matter. Some features of a country whose development is lagging?? Employee voting in management structure, state intervention in research and development, and strong public sentiment to protect existing social communities (and all corporate stakeholders other than shareholders) from "disruptive market forces." He has unwittingly listed the agenda of some of our current Presidential candidates.