Saturday, June 4, 2016

How much paternalism do we need?

How much do we trust institutional investors to protect their interests?

Delaware law has gradually been inching toward a recognition that in a stock market dominated by institutional investors, old assumptions – about a dispersed,  uninformed, and rationally passive shareholder base – must give way to a new recognition of shareholder sophistication and incentives.

You can see the tendrils of this growing awareness in, for example, opinions like Corwin v. KKR Fin. Holdings LLC, 125 A.3d 304 (Del. 2015), where the Delaware Supreme Court held that a shareholder vote in favor of a merger would act as a ratification of the directors’ conduct – a ruling that implicitly relied on an expectation of shareholder sophistication.  See id. (“When the real parties in interest—the disinterested equity owners—can easily protect themselves at the ballot box by simply voting no, the utility of a litigation-intrusive standard of review promises more costs to stockholders in the form of litigation rents and inhibitions on risk-taking than it promises in terms of benefits to them.”)  You can see it in then-Vice Chancellor Strine’s opinion in In re Pure Res. S'Holders Litig., 808 A.2d 421 (Del. Ch. 2002), where he held that controlling shareholder tender offers need not always be subject to entire fairness review, in light of the “increased activism of institutional investors and the greater information flows available to them” – which influenced later standards applied to the merger context.  See Kahn v. M&F Worldwide Corp., 88 A.3d 635 (Del. 2014).

You can also see it in Myron Steele’s recent lecture at Fordham, where he predicted that “it’s only a matter of time before substantive coercion is history. Because when you have a seventy-five percent institutional stockholder base, it’s not like you're their guardian. They’re perfectly capable of making their own decisions…”  See 20 Fordham J. Corp. & Fin. L. 352 (2015).

But in In re Appraisal of Dell, 2016 Del. Ch. LEXIS 81 (Del. Ch. 2016), Vice Chancellor Laster pooh-poohed market judgments, embarking on a prolonged discussion about why shareholders – and even market analysts – might fail to recognize the value of new investments with long term payoffs, not even necessarily because they lack information, but because of what he deemed an “anti-bubble.”  The most eyebrow-raising moment came when, in support of this thesis, he cited Martin Lipton’s blog posts at the HLS Forum and CLS Blue Sky.  Martin Lipton**, of course, frequently argues that shareholders are uninformed and not to be trusted, in support of a general agenda of minimizing shareholder power and maximizing management discretion.

All of this just begs the question:  if shareholders’ judgments are so untrustworthy, why do their votes in favor of a merger have such an immunizing effect?*


*the contradiction is made more obvious by Martin Lipton's recent blog post decrying the Dell decision; the irony, of course, is that Lipton's own arguments were used to justify the court's conclusion that shareholder valuations are unreliable.

**in case anyone was wondering, no relation.

Ann Lipton | Permalink


Astute observations Ann. Perhaps mergers into new companies where individual shareholders continue to be protected by institutional investors and retain some flexibility in (exit) options makes courts more inclined to trust the wisdom of the institutional investors driving the vote. When the exit is a going private buyout (by an interested party no less) then the implicit standard is raised? The skepticism reinserted and elevated because there is no hope for future protection or correction? -Anne Tucker

Posted by: Anne Tucker | Jun 8, 2016 7:19:36 AM

Hi Anne! I definitely think MBOs and going private transactions have a different context - but Pure also involved a controlling shareholder, as did Kahn. I think Delaware is trying to recognize a greater degree of shareholder sophistication but hasn't yet worked out the precise balance.

BTW, great to meet you at LSA - I hope our paths cross again soon.

Posted by: Ann Lipton | Jun 8, 2016 8:55:16 AM

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