Friday, July 10, 2020
The Delaware Supreme Court has, shall we say, an uneven relationship with the concept of market efficiency.
For many years, it entirely ignored or even disdained the concept. See Verition Partners Master Fund Ltd. v. Aruba Networks, Inc, 2018 WL 922139, at *30 n.305 (Del. Ch. Feb. 15, 2018). However, beginning with DFC Glob. Corp. v. Muirfield Value P’rs, L.P., 172 A.3d 346 (Del. 2017), the Court began to endorse the concept in the context of appraisal proceedings, though the significance it placed on efficiency was not entirely clear. When Vice Chancellor Laster relied entirely on market efficiency to value shares for appraisal purposes, the Delaware Supreme Court rejected his analysis, emphasizing that market price is but one aspect of an appraisal valuation, and that “informational” market efficiency is not equivalent to “fundamental value” efficiency.
The Delaware Supreme Court’s new decision in Fir Tree Value Master Fund LP et al. v. Jarden Corporation seems to muddy the waters further.
Originally, VC Slights held that a target’s market price was the best evidence of standalone value, mainly because the other potential measures were lacking. The deal price was flawed because the target CEO had arguably run an inadequate process, and in any event, there were likely synergies to which the petitioners were not entitled. It was impossible to determine exactly how those synergies had influenced the deal price, so they could not simply be deducted, and the parties had wildly divergent DCF analyses. Under these conditions, VC Slights awarded petitioners the unaffected market price – which was, unsurprisingly, below the deal price.
On appeal, the Delaware Supreme Court affirmed. Most of the opinion emphasizes that Chancery courts have broad discretion to consider multiple valuation methods – including deal price and market price – and Slights did not abuse his when he determined that market price was most appropriate in this case. The court quoted its earlier holding in DFC, explaining, “Like any factor relevant to a company’s future performance, the market’s collective judgment of the effect of regulatory risk may turn out to be wrong, but established corporate finance theories suggest that the collective judgment of the many is more likely to be accurate than any individual’s guess.”
We might ask how well Jarden squares with Aruba. After all, in Aruba there were also synergies to discount, an unreliable sales process, and a concern about DCF calculations, but the Delaware Supreme Court rejected VC Laster’s reliance on market price. The Delaware Supreme Court explained itself in Aruba by saying that VC Laster erred by holding that he was compelled to rely on market price, when, in fact, other evidence was available. What really seemed to be troubling the court, though, was discomfort with a blanket endorsement of market efficiency, particularly because of the likelihood that acquirers have better information than the market in general. VC Slights’s Jarden opinion, by contrast, did not seem to the Supreme Court as categorical, and thus did not, ahem, take Delaware out of the public-company appraisal business entirely.
But the court didn’t leave things there.
In affirming VC Slights, the Delaware Supreme Court also cited an article by Jonathan Macey and Joshua Mitts, Asking the Right Question: The Statutory Right of Appraisal and Efficient Markets, 74 Bus. Law. 1015 (2019). This was an odd choice, because that article strongly endorses the use of market price as a starting point for virtually all appraisal proceedings, and offers an extreme defense of market efficiency. In the section of the article quoted by the Delaware Supreme Court, Macey and Mitts write, “[B]ecause informational efficiency and fundamental efficiency are not the same thing, the share price of a company’s stock, even when informationally efficient, may diverge occasionally from the stock’s fundamentally efficient price. This divergence occurs, however, only when and to the extent that there is material nonpublic information that is not impounded in a company’s share prices.”
That is… not the same analysis as the one in DFC. The Mitts and Macey quote suggests that if a market is informationally efficient, courts should assume the market price reflects fundamental value unless there’s identifiable material nonpublic information, in which case price is adjusted accordingly. By contrast, DFC holds that market judgments can be wrong even if everyone’s working off the same information, though the collective judgment is probably right. DFC, in other words, allows for the possibility that markets may misapprehend the significance of the information with which they are supplied; in practical effect, it gives courts more wiggle room. And in Aruba, of course, the Delaware Supreme Court did not suggest that VC Laster should have awarded market price adjusted for nonpublic information.
More perplexingly, a second Jarden footnote quotes Mitts and Macey’s pronouncement that “Delaware Courts are correct in affording primacy to the [efficient capital market hypothesis] in valuation cases,” while contrasting with Lynn Stout on problems with the ECMH. Is the court … endorsing Mitts and Macey’s interpretation of its own caselaw, that market prices have “primacy”? I can’t really tell, but other aspects of the decision seem to take the Mitts and Macey view, because, in rejecting the petitioner’s challenge to the use of market prices, the court highlights (1) petitioners did not identify material nonpublic information and (2) differences among analysts reflected mere judgment differences rather than informational differences, which - in the court’s view - made them irrelevant. (See, e.g., op. at 32-33).
There are, of course, well-known difficulties with assuming that informationally-efficient markets reflect fundamental values. First, it’s hard to tell when you’re actually in such a market in the first place. That’s a longstanding problem in the fraud-on-the-market context, which is why the Supreme Court recently explained that perfect efficiency is not necessary for fraud-on-the-market plaintiffs. Mitts and Macey acknowledge this point in their article, and suggest that courts simply start with the inefficient prices and adjust them for any unaccounted-for information, but that presupposes that courts can detect such inefficiencies, detect the missing information, and make the appropriate adjustment.
The other problem is that of the irrational market, even when all information is clearly available. As I previously posted, we’re seeing precisely these kinds of markets right now, as retail traders turn to RobinHood to get their gambling fix and apparently engage in price manipulation for the lulz. As pandemic-related uncertainties cause wild gyrations in stock price, this is, perhaps, not the best moment for a full-throated endorsement of market efficiency. Mitts and Macey largely suggest that if markets are irrational in general, investors don’t deserve an appraisal remedy anyway, but I am not certain that view accords with Delaware precedent.
In any event, I don’t want to overstate things; in general, I think the takeaway from Jarden is likely to be that Chancery judges have leeway to use the evidence they think most appropriate to the situation, and unaffected market price is acceptable at least when deal-price-minus-synergies is incalculable. It’s just striking that, in support of this holding, the court quoted an article making, umm, the opposite argument, which may create uncertainty with respect to the great “deal price versus market price” debate.