Business Law Prof Blog

The Harman Buyout

The new KKR buyout of Harman International Industries Inc is getting press for its offer to include the Harman shareholders in the buyout group.  The offer is a symptom of a much larger problem, the conflict of interest inherent in buyouts that include managers in the buyout group.  The Harman offer attempts to blunt the criticism by giving target shareholders the option of also joining the buyout group.  This is no solution; it is a band-aid.  First, the target shareholders will hold a partnership in the buyout group with no control powers and, second, unless the target shareholders receive a return identical to the managers that participate in the buyout group (and this is not going to be true -- I did not fall off the turnip truck), the conflict remains.  If the motivation is pure financing, the buyout group will be able to reduce reliance on other funding sources, it makes sense.  As a move to blunt criticism of conflicts -- it ought fail.

Cross-Listing Premiums

A new study by Karolyi, Stulz & Doidge, which Professor Stulz has hinted was coming for some time, documents that the Sarbanes-Oxley Act of 2002 does not adversely affect the appeal of United States stock markets to foreign company seeking to list shares.  United States listings still offer substantial cross-listing premiums on stock prices (due, in theory, to superior regulation) and London listings do not.  The decline in the number of listings in the United States after 2002 is due to the fewer number of companies that are eligible to be listed, not the Act they argue.  There is some contrary evidence; the explosion of our Rule 144A market in foreign stocks (an exempted offering) and the success of the Toronto and London AIM small offering markets as compared to our own small offering markets.  There is also an alternative theory: We have established a very high standard of reporting that only very large, well run companies can use as a "seal of approval."  It makes sense for them to do so; smaller and medium companies with more average business practices no longer find is sensible to incur the high costs of using the "seal."  At issue is whether we should apply a top "seal of approval" system to all our companies.  Is the growth of small and medium companies too hindered by such a requirement?         

The Contest for ABN AMRO Holdings

Barclays deal with ABN AMRO Holding NV and the appearance of rival suitor Royal Bank of Scotland Group will, if it gets to court in the Netherlands, will offer the Netherlands judges a problem that is familiar to United States lawyers.  In a friendly deal, how far can the two parties go in including terms that lock out new bidders for either of the parties?  In Barclays deal, the parties included a version of a "crown jewel" defense -- the sale of a prized subsidiary (LaSalle Bank) to a white squire (Bank of America).  The suitor has to break the sale for the rival deal to make economic sense.  The situation is classic: The appearance of the higher bid from the suitor is contingent on voiding the deal protections and both the suitor and the shareholders of the target (who want the higher price) join hands to attack the protections.  Judges, if they get the case, must decide on whether the target board misbehaved when it signed the deal protections.  Our leading court, the Delaware Supreme Court, has mucked up the issue in the Omnicare case (818 A.2d 914 (Del. 2003)); we will see if the Netherlands judges can do better. 

Steve Jobs and Backdated Options

The SEC has announced the civil prosecution of two Apple executives (the ex-CFO and the ex-Chief Legal Counsel) for backdating compensatory options and the settlement of one of them (against the CFO). Steve Jobs was not prosecuted.  He did take a hit in the statement made by the CFO, however, who once again noted that Jobs knew about and was involved in the backdating of at least one large option grant to Apple employees in 2001.  The SEC's failure to prosecute Jobs in light of the statement is yet to be explained.  In any event, just when I am ready to throw in with those who want to stop private securities class actions a case like this comes along and I am glad that private actions against Jobs are available (and ongoing).    

The Other Shoe Drops on Wendy's

Wendy's is looking for a buyer.  The final act is about to open on the two year interest in Wendy's by several prominent hedge funds.  In the opening acts the hedge funds bought Wendy's stagnant shares, demanded that the board spin off two profitable subsidiaries (which it did), eased out the CEO, and negotiated for three seats on the board of directors.  In response, Wendy's management took advantage of a rising stock price to cash in some options and received a standstill agreement from the most prominent of the hedge fund operators (Peltz).  The standstill is expiring. Peltz is still interested and the board is rumored to be considering putting the company up for sale.  The entire drama unfolded in a company with a staggered board and the multiple anti-takeover protections in Ohio legislation.  The lesson? The old anti-takeover protections no longer work against determined hedge funds. The threat to mount a proxy fight against for even one-third of the seats works if those seats include insider heavyweights up for re-election (the CEO or the CFO).

Tribune Acquisition Begins

The Tribune Corporation took the first step on its acquisition by Sam Zell today, commencing a large share buyback.  The second step, a leveraged acquisition of the rest of the company stock by an ESOP will take place after the necessary regulatory approvals are secured.  After the leveraged ESOP, Zell will hold a deeply in-the-money warrant on 40% of the stock and control the company through a management contract.  The deal financing takes advantage of tax beaks awarded ESOPs, a flow through tax structure (a Sub S), the tax advantages of leverage, and the current spate of cheap money (low interest rates).  Zell has never run a newspaper but he knows how to find value in depressed assets (his nick name is the "grave digger"). This is a bust up takeover, pure and simple; he will sell the assets and piece out the company, having found some nugget (or nuggets) that the market has overlooked.  The surprise in the package for me is the participation of the newspaper employees.  They are Zell's new owner/partners and must support the deal for it to go through.  What is in it for them?  They lose other benefits to hold the stock which means they are severely undiversified investors with both salary and benefits linked to a company with failing revenues and their new boss will bust-up the company.  Employees usually hate bust-ups, fearing the loss of their jobs.  I am still scratching my head over why the unions are going along with this. The irony is that the taxpayer is also a partner, through the tax breaks given leveraged ESOPs.  The tax breaks favor ESOP so that employees can own a share of their own companies; employee ownership was thought to produce longterm employee satisfaction and company health.  Congress did not anticipate that employees could be the passive partners in a bust-up of their own company.  Congress will have to reconsider the tax breaks for ESOPs after this deal.      

Do The Right Thing

Dow Chemical publicly announced today that it had terminated two high-ranking executives, one a member of its board of directors and former chief financial officer, for unauthorized discussions with third parties (read private equity firms) concerning a leveraged buy-out of the company.   Dow, a company with a $45 billion market capitalization, has recently been rumored as one of the next "mega" private equity LBOs.

As the private equity craze continues to froth, it is becoming increasingly hard for boards to control insiders who otherwise wish to participate.  Officers, and even independent directors, are initiating sales processes themselves or otherwise requesting to join in the bidding with or against other potential acquirers.  These insiders usually stand hand-in-hand with private equity shops who provide necessary LBO financing.  Hint of this problem recently surfaced when it was reported by the Wall Street Journal back in September, 2006 that the top management at Kinder Morgan waited more than two months to inform their board of directors that they were contemplating an ultimately agreed to LBO.  The risk here for all companies is that these executives or directors will have an undue head start or inside track on bidding, and this is a risk largely regulated today through traditional duty of loyalty analysis.  The Delaware Chancery Court has previously criticized such conduct, but it has yet to consider the parameters of the duty of loyalty in this context.  In the interim, boards would do well to be mindful of this potential and amend their codes of conduct to require insiders to report commencement of active planning for a management buy-out. 

Steven M. Davidoff   

London Regulating?

The FT reports here that the Financial Services Authority, the U.K.'s financial markets regulator, announced last week that it is going to study toughening up the requirements for foreign listings on the London Stock Exchange.  Currently, foreign issuers cross-listing on the LSE are subject to "light touch" regulation which principally requires maintenance of their primary listing and the furnishing of certain documents to the FSA.  The FT reports increasing fear in the City community that this light regulation will tarnish the LSE's reputation through scandal or generally perceived diminished quality.

The move is surprising on two levels.  First, the LSE had a spectacular year last year with respect to foreign issuers; of the £28 billion raised in IPOs on the LSE fully £10 billion was from foreign listings, the majority from the CIS states and India.  Second, London has been furiously marketing itself as an alternative market for Sarbanes-Oxley "refugees".  Why the FSA would act now to tighten regulation when things are going so well is uncertain and perhaps harmful to its own markets at a time of rising competitiveness.  But, I suspect part of the reason lies with the AIM, the LSE's similarly lightly regulated junior market.  It had a mixed year last year; attracting a large number of foreign IPOs itself but being criticized repeatedly for a number of scandals.  Moreover, the AIM was slightly down in 2006 and half of its largest IPOs were trading below their offering price by the end of last year.  The LSE has announced that it is considering raising regulatory standards for the AIM, and the concerns over light regulation have likely spilled over to the LSE.  But, London knows it has a good thing going in distinguishing itself from the United States.  The FSA may increase regulation of foreign issuers on the LSE at a later date, but they will be careful to set it apart from claimed "over-burdensome" U.S. regulation.  The bottom line is that any additional regulation will be measured.  Until the United States effects radical change, London is likely to continue to differentiate itself from the U.S. markets and better cater to its foreign issuers/customers by offering regulation more tailored to their needs. 

Steven M. Davidoff

Attacks on Private Equity Funds

Unions, long suspicious of private equity fund buyouts (leverage buyouts or LBOs), have a sympathetic ear in Congress.  Barney Frank, chair of the House Financial Services Committee, is rustling about attempting to find ways of regulating LBOs.  His basic complaint is that the LBOs do not help and often hurt rank and file employees (in particular unionized employees).  He seems to want to limit buy-out funds access to debt to finance the deals.  He will have trouble.  Buyout funds are taking advantage of a broader market phenomenon -- debt is cheap because it is subsidized and control by the government.  The federal government favors debt in the tax code and the fed keeps debt at below free market rates.  Buyout funds are using subsidized debt (interest rates are too low).  Too many across the financial markets (both main street and wall street) are invested in low interest rates to change this. Disabling one actor, private equity funds, from using debt, will merely embolden and empower others (who are probably less efficient but just as willing).

Take-Two Proxy Fight

The success of the dissident shareholders in the annual meeting of Take-Two Interactive Software, Inc., is stunning (five new directors and the firing of the CEO) and may be a harbinger of a new day for corporate governance.  Institutional investors held large stakes in the company, got together when problems surfaced, and in a no-nonsense show of steady strength, put a turnaround artist in control of the company. The ousted CEO tried to sell the company and delay the annual meeting but in the end, he lost.  The meeting will have long run effects -- it will encourage institutional investors to be active and, most important perhaps, it will encourage outside directors (two of whom survived by aligning themselves with the dissidents) to switch sides when it is obvious that there are internal problems.