Art loving billionaire. Photographer: Simon Dawson/Bloomberg
Art loving billionaire. Photographer: Simon Dawson/Bloomberg

I bet Dan Loeb is really looking forward to his first meeting as a member of the Sotheby's board of directors. Certainly his new colleagues are excited to have him:

"We welcome our newest directors to the Board and look forward to working with them, confident that we share the common goal of delivering the greatest value to Sotheby's clients and shareholders," said Bill Ruprecht, Chairman, President and Chief Executive Officer of Sotheby's.

Here are some other things that Bill Ruprecht has recently said about Loeb:

"We are going to be the target of a proxy fight with activist shareholders. The motivation for that fight is only peripherally about returning capital. It is about being on Sotheby‘s Board. Mick McGuire needs that as validation, and Loeb wants that for ego." ...

"[W]hen, and if, we cannot defeat a hostile proxy fight, these [jerks]1 can run the business. I will not supervise the over leveraging of this business which leads to wholesale termination of staff and suffocating debt." ...

In the context of discussing the Company's real estate plans, [Sotheby's board member Robert] Taubman emailed Ruprecht that "this all happened because of Loeb." Ruprecht responded with a single word: "scum." ...

"Loeb wants to control our board. Our staff would hate that. He‘s a scumbag."

But he meant it in a nice way! And to be fair Loeb ... Loeb also said some weird things:2

In contemporaneous emails, Loeb described his letter as both part of a "holy jihad" intended to "make sure all the Sotheby‘s infidels are made aware that there is only one true God," and part of a "Special Operation on Sotheby‘s," which was intended to "shock and awe" the Company and "undermine the credibility" of Ruprecht.

All of those quotes are from Friday's riveting Delaware Chancery Court decision in Loeb's lawsuit against Sotheby's. The short version: Loeb had been running a proxy fight to get himself and two other nominees on the Sotheby's board of directors. He was hampered in that effort by Sotheby's poison pill, which restricted him from buying more shares. He sued Sotheby's to make it get rid of the pill. On Friday, he lost that lawsuit. On Monday, Sotheby's caved, agreeing to put Loeb's nominees on the board.

So ... that's weird, huh? Loeb lost a battle and then immediately won the war. The obvious explanation is that the poison-pill lawsuit was just a side issue; the main issue is not the poison pill but just who was going to win the vote. In the lawsuit, everyone seemed to agree that the vote was "a coin flip" or a "dead heat."3 I suppose if you're Sotheby's, a 50/50 chance of losing three directors, and having them replaced by three hopping-mad Loeb appointees, is not that appealing. (The settlement expands the board to avoid throwing anyone out.)

Plus, I mean, the lawsuit could have affected those odds. Discovery brought out a ton of interesting quotes. Not just the ones about Loeb being a "scumbag," I mean. Here are some other things that Sotheby's directors said to each other, which Dan Loeb helpfully collected in a proxy filing last week (emphasis his):

"I see some combination of a flawed governance process, highly flawed internal controls and accountability, carelessness, and extraordinarily bad judgment at work here. Harsh? Yes, but I’m afraid not off the mark….the evidence is strong that [the] company has a serious set of expense and comp issues and that the Board and [sic] is too comfortable, too chummy and not doing its job."

"We spend too much on people, travel, entertainment, client relationships etc…. don’t know how spending was allowed to get that far out of control, with no real comments by management…. Again, I think Bill [Ruprecht’s] strategy was – revenue and people at whatever the cost. Tough part is, we as a board didn’t know that was his approach so didn’t have the opportunity to debate it."

Ha, oops. When you've got directors going around saying that they're not doing their job, a coin-flip proxy fight becomes harder for the incumbents to win. After those e-mails, you could see why Sotheby's would want to cut its losses and give Loeb some board seats.

The whole opinion -- or at least, the first 31 pages, with all the facts -- is worth reading. Generally I find that Delaware Chancery Court opinions are the best places to read the stories of hostile M&A battles, but you don't usually find them telling the stories of activist battles. This one does and it is consistently fascinating.4

Here's the weirdest part of the story: Loeb is barely in it. I mean, that's an exaggeration; he buys shares and takes meetings and exchanges weird e-mails.5 But the Loeb who matters to this story is mostly a figment of the collective imagination of Sotheby's board and advisers. Ruprecht, the CEO, consistently assumes that Loeb will demand that Sotheby's return capital to shareholders.6 Sotheby's advisers at Goldman Sachs and Wachtell, Lipton, Rosen & Katz told the board a scary story of hedge fund "wolf packs" and takeover threats.7

And they tried to preempt Loeb by doing what they assumed he wanted. Ruprecht urged:

Now, I do not have an appetite for significantly leveraging this business, our progress has been hard won, and our ability to operate and invest in deals, and potentially an art fund principal business has never been more exciting.

My review of the situation however is this: if we make a gesture, that we can afford, of a couple of hundred million returned quickly to shareholders, we gain enormous tactical leverage in the process of persuading the 85% of shareholders who were not activists, that we are responsible stewards for their investment.

And Goldman agreed:

During the Finance Committee meeting, Goldman made a presentation recommending a $200-$250 million share repurchase as part of a two-step process to address "recent shareholder feedback." While Goldman noted that one of the "potential consequences of inaction" was that "vocal shareholders" would "[p]ropose a short slate of 2 to 3 alternative directors," it also described some of the "key risks" of engaging in a share buyback as adding "additional leverage to a highly cyclical business," and creating the "[p]otential for Marcato/Third Point to 'claim victory,'" and the "[p]otential loss of operational flexibility in the U.S."

But Loeb never asked for increased leverage or share buybacks!8 The complaints in Loeb's October letter to Sotheby's, and his April proxy solicitations, and in the meetings and e-mails described in the opinion, are not about share buybacks. They are about strategy. They are about expanding the business for the long term, not about cutting it to hand money back to shareholders now. In October:

Auctions, private and internet sales all need to be reinvigorated or revamped. Sotheby’s global footprint must expand, and opportunities to exploit the Sotheby’s brand through adjacent businesses should be considered. Sotheby’s can also use its unique position and potential excess capital to judiciously take principal positions in works of art when doing so would not conflict with its clients’ interests.

In April:

  • Invest in data technology to record private sale and auction inquiries to promote cross-selling, improve customer service, and increase volume. Once the tools are in place, Company employees must be managed effectively to drive cross-selling to capture a greater share of each customer’s relevant spending.
  • Invest in front-end technology to facilitate online sales, increase customer engagement, and burnish the Sotheby’s brand.
  • Invest in long-term talent development and cultivate numerous points of contact within Sotheby’s so that art buyers become clients of the Company, not just the individual salesperson.
  • Initiate a greater number of curated auctions and exhibitions to leverage Sotheby’s client base and relationships.
  • Use its trusted position as advisor to engage in both auction and private sales to represent artists’ estates.
  • Use its capital more aggressively, sometimes jointly with trusted partners, to secure works for private sale and auction.
  • More aggressively seek to monetize Sotheby’s deep intellectual property in its core markets through more active financing and principal investing.
  • Develop a robust approach to smaller transactions to compete more effectively with Christie’s.

I am obviously not the right person to tell you if these were good ideas for Sotheby's, but they're clearly not slash-the-business-and-give-shareholders-the-cash ideas.9 The dynamic here was not a board focused on long-term value creation resisting the short-term capital-allocation demands of an activist shareholder. The dynamic was a board focused on its own preservation -- Ruprecht actually says "the single most valuable thing the board can do is stay collaborative and speak with one voice, and control its future" -- taking short-term capital-allocation actions to try to undercut an activist shareholder focused on long-term value creation.

The court was okay with that, and this opinion suggests that Delaware courts will be okay with more or less anything that directors do to keep themselves in power.10 Corporate boards need this power to resist the threat of activist investors, those rapacious bandits who travel in wolf packs and push companies to ignore long-term value creation in favor of funneling cash to shareholders. That's the story, anyway, whether or not it's true. Here, I'm not sure it was. But I guess the Sotheby's board will find out, in person, soon enough.

1 That bracketed "[jerks]" is in the court decision. I don't know what Ruprecht actually said. I hope it was "investors."

2 That actually seems to have been a joke:

In a written statement, Mr. Loeb said he has "an irreverent sense of humor" and that the email stated that the comments were a "joke and not intended to offend." He disputed other "silly comments" attributed to him and said they were "either not serious or third-hand gossip."

3 That's footnote 30 of the opinion.

4 Right from the list of parties on page 4, which includes "Peregrine A.M. Cavendish, the Duke of Devonshire," the deputy chairman of Sotheby's board, who one hopes is especially chummy. In a surprisingly monarchist twist for an American court, he's referred to as "the Duke of Devonshire" throughout the opinion.

5 And receives internal presentations suggesting that one option for Sotheby's would be to "Push mgmt. to explore strategic alternatives and let an art loving billionaire [i.e., Loeb] (or the Qataris) take [Sotheby‘s] private." I love that the court interjected "i.e. Loeb" there; there are other art loving billionaires you know.

6 E.g. the "[jerks]" comment about over leveraging the business, or this from Ruprecht before meeting with Loeb:

Suspect that they agitate for real estate sales, syndication of our loan book, and return of capital to shareholders. They will bitterly condemn me, as a power hungry despot having insisted on assuming Chairmanship etc. and that all [C]EO‘s are wildly overpaid, and that they want multiple board seats. While none of their ideas will likely bear material fruit, they raise money on the basis that they activate management teams.

7 I suppose this is as good a place as any to put in the usual disclaimer that I used to work at both Wachtell and Goldman, including with the individuals named in the opinion. They teamed up to do this:

The Board received information in a presentation jointly prepared by Wachtell and Goldman describing the stockholder activism market generally and stockholder activism issues specific to Sotheby‘s. Regarding activism in general, the Board was informed that stockholder activism levels were "high," at least in part because of activists‘ prior successes in waging proxy contests. The presentation also contained a slide titled "Activist Investor Tactics Typically Follow a Familiar Pattern." According to the presentation, this pattern usually consists of activists building a stake in an entity, individually or by teaming up with other institutional or activist stockholders to form a "wolf pack," applying pressure on the entity, including threatening to agitate against a board‘s preferred strategic alternatives, and finally taking action against the board by threatening "withhold the vote" campaigns, demanding board seats, launching a short-slate proxy contest, or making aggressive use of derivatives.

Aggressive derivatives! Also:

For Third Point, the overview noted Loeb‘s penchant for authoring "poison-pen" letters and the fund‘s focus on "event-driven situations such as mergers, acquisitions, tender offers, recapitalizations, spin-offs, exchange offers and liquidations." On a slide comparing the "agendas" Trian, Marcato, and Third Point had pursued in previous activist campaigns, Goldman and Wachtell reported that Third Point had, among other things, bid for a company in which it had invested. The Board‘s financial and legal advisors also discussed with them Third Point‘s previous successes in negotiating a transaction with entities it had invested in that arguably allowed it to obtain a benefit that was not available to the entity‘s other stockholders. An example was the repurchase by Yahoo! of 40 million of its shares from Third Point.

8 I mean, to be fair, Marcato, another activist fund that built up a position in Sotheby's, did.

9 Though Loeb wanted some cost cutting too:

In the course of our investigation into the Company’s business practices, we came across numerous anecdotes of waste. Typical of the egregious examples was a story we heard of a recent offsite meeting consisting of an extravagant lunch and dinner at a famous “farm-to-table” New York area restaurant where Sotheby’s senior management feasted on organic delicacies and imbibed vintage wines at a cost to shareholders of multiple hundreds of thousands of dollars. We acknowledge that Sotheby’s is a luxury brand, but there appears to be some confusion -- this does not entitle senior management to live a life of luxury at the expense of shareholders.

10 Pages 50-52 are the legal meat of the decision, finding that "negative control" -- the ability to, like, block a merger? -- is enough of a threat that a board can act to block it. So, basically, a board can block any big stake just because it's big. Footnote 39 on page 52 softens this a little, saying that Loeb's arguments "appear to be at least colorable and raise important policy concerns that deserve careful consideration," but in the context of a preliminary injunction I guess he didn't give them that consideration.

To contact the writer of this article: Matt Levine at mlevine51@bloomberg.net.

To contact the editor responsible for this article: Tobin Harshaw at tharshaw@bloomberg.net.