In theory, corporate directors work for their shareholders, and in theory you might think that that would be a precarious existence. Your shareholders are changing every 100 milliseconds! How can you concentrate on your job if, at any moment, someone could come in and buy a bunch of shares and tell you to change everything you're doing?
But, nope, it's great, you're basically un-fireable and can do whatever you want. There are lots of protections that have evolved against the risk of being bossed around, or fired, by public shareholders. There are Securities and Exchange Commission disclosure rules, which give boards notice of new large shareholders.1 There are SEC proxy rules, which mostly let directors refuse to hold a vote on annoying shareholder proposals. And there are takeover protections, like poison pills and staggered boards, which mostly prevent anyone from buying a whole company without the approval of its directors.
Also, directors can just refuse to let anyone they don't like buy more than 10 percent of their company's stock. This has fairly obvious benefits for job security; it's good to have veto power over your boss. But the way directors do this -- by enacting a poison pill that is triggered if any shareholder buys more than 10 percent of the stock -- is on somewhat untested legal ground. The going rate in 2014 seems to be that you can put in a poison pill that limits activists to owning no more than 10 percent of the company, and even in the absence of a takeover threat. But the courts last looked at poison pills in 2010, when the going rate didn't go as far.
Here is a chart of the situation; of course the chart is not your lawyer and cannot provide legal advice:2
There's some chance that we'll find out if the lawyers are right, since Dan Loeb's Third Point Capital, which owns 9.62 percent of Sotheby's, is running a proxy fight to elect three directors and shake up management, and is the obvious target of Sotheby's 10-percent-trigger poison pill, today filed a lawsuit to get rid of that pill. Loeb:
The Board's adoption of this discriminatory Poison Pill -- and its refusal to amend it in response to Third Point's request -- demonstrate that the Poison Pill is not a reasonable corporate response to a takeover threat, but rather an improper attempt to thwart Third Point's proxy contest and ensure that the current Board members remain firmly entrenched.
The Board believes this plan is an important tool to ensure that all Sotheby’s shareholders are treated fairly, including in the context of rapid accumulations by 13D filers. The plan is designed to limit the ability of any person or group to seize control of the Company without appropriately compensating all Sotheby’s shareholders. It provides the Board and shareholders with time to make informed judgments.
I mostly agree with Loeb here, but you knew that already. While I have a certain soft spot for companies that, say, go public without giving shareholders any say over their affairs, the question here is whether any Delaware public company board should be able to keep activists out of its stock. I still think fondly of the poison pill as a way to prevent shareholders from being subjected to coercive takeover offers, and the extension of the pill to non-takeover activism just feels wrong to me. Like Loeb says, this pill seems to me to be about the board's job security, not protecting shareholders.3
Will courts agree? That I do not know; like the chart says, Delaware courts have not yet approved poison pills that are as aggressive as Sotheby's, but on the other hand Sotheby's('s) lawyers presumably know what they're doing.4 I, on the other hand, do not, though on my casual reading of some random stuff I suspect they have a case. The relevant test is whether Sotheby's has reasonable grounds to believe that Loeb poses a threat, and whether the pill is a proportional response to that threat.
As to the threat -- well, like I said, I don't see it, but the Delaware court might think that any activist interference with the board is threat enough.5
If there is a threat, then the question becomes whether the pill is a reasonable response, and "the key issue is whether the Rights Plan unreasonably inhibits the ability of [Third Point] to run an effective proxy contest." And there ... I dunno, Third Point is running a proxy contest.
We can't tell yet if it'll be an effective proxy contest, but I guess there's some reason to hope. For one thing, activists are having ever more success in getting long-only institutional shareholders to support their campaigns. For another, Loeb has plenty of arguments that Sotheby's board could use a shake-up. The job-preservation poison pill, for instance, is a pretty good argument all on its own.
And short-swing profit rules that make concentrated ownership onerous.
The courts approved 20 percent, mild-takeover-threat pills in Yucaipa v. Riggio, a 2010 opinion written by then-Vice Chancellor Leo Strine, who is now Chief Justice of the Delaware Supreme Court. Corporate lawyers have approved 10 percent, activist-only pills in Hertz, Sotheby's, etc.
Note that NOL-preservation poison pills, which trigger at 5 percent, are a whole separate issue and not relevant here.
3 Loeb's complaint notes that the pill allows passive shareholders to go up to 20 percent: If you're more likely to be supportive of management, you can buy more shares.
Incidentally: A while back I wrote about Lions Gate's efforts to get rid of Carl Icahn, and described "the background of cynical assumptions about all takeover battles: Management just wants to keep itself in power, while the hostile bidder just wants to make a quick buck by buying the company at below its fair value." A reader e-mailed to complain about the implied equivalence, saying "Granted, some bidders are after greenmail or other nefarious payoffs; but all managements are in the wrong." I feel like that position is not uncommon. (Nor really wrong?)
5 For instance, in Yucaipa, Vice Chancellor Strine wrote:
Yucaipa’s constant disclaimer of any willingness or intent to buy the company as a whole does not, in my view, undercut the reasonableness of the board’s determination that Yucaipa posed a threat. Indeed, the fact that Yucaipa has not made a bid for the company is in some ways the point. In Burkle’s stinging letters to Riggio, Burkle himself raises many of the plausible concerns regarding the problems that arise when a large blocholder is able to exert influence through several board seats and the potential that the blocholder will use that influence to advance its own self-interest, consciously or unconsciously, in a manner that is adverse to the company’s other owners. The board was not required to assume that Yucaipa is an angelic investor whose actions, unlike that of other humans, are immune from the temptation to act selfishly, especially when there is a record that Yucaipa has negotiated for itself special protections in connection with others of its investments and has reserved to itself the right to take Barnes & Noble private. Rather, the board could reasonably assume that Yucaipa, like other profit-seeking investors, might pose a danger to other company investors if it, in concert with a party like Aletheia, obtained strong unilateral control over a major portion of the company’s voting securities. Likewise, the board could reasonably conclude that Yucaipa should deal with the board in the first instance if it wished to obtain such a bloc, and to pay a price to the company’s investors that reflected the value of obtaining that power
The other day now-Chief Justice Strine published an interesting essay in the Columbia Law Review that is fairly critical of activist investors. The essay more or less explicitly endorses a Sotheby's-like pill:
The presence of a garden variety poison pill preventing the acquisition of more than ten to twenty percent of the corporation's equity without board approval has another important, but often overlooked, protective effect for stockholders. The pill works to prevent a creeping takeover whereby effective negative control over a corporation is acquired without the payment of a control premium. Given the amount of stock that can be acquired before disclosure is required under Rule 13d, a reality discussed elsewhere in this Essay, the absence of a pill can leave stockholders in a corporation that has activist stockholders owning an amount of stock that would act as a huge deterrent to any potential acquirer without having had to pay a control premium; indeed, an amount that in the European Union would often trigger an obligation to make a mandatory bid for all shares.
Note "ten to twenty percent," and the idea that a board should be able to block a large activist stake because it might deter takeovers.
To contact the writer of this article: Matt Levine at email@example.com.
To contact the editor responsible for this article: Tobin Harshaw at firstname.lastname@example.org.