Let me begin by thanking Gordon Smith and the other organizers of the Conglomerate for inviting me to guest-blog here for the next two weeks.
As far as I can tell, little has been said here about the Delaware Supreme Court’s decision last month in Kahn v. M&F Worldwide Corp. As many readers will already know, the case concerns the standard of review to be applied to the decision of a board of directors of a controlled corporation when the directors approve a freeze-out merger between the corporation and the controlling stockholder.
Under Weinberger v. OUP, Inc., 457 A.2d 701 (Del. 1983), freeze-out mergers were traditionally reviewed under the entire fairness standard with the burden of proof resting on the controlling stockholder. Under Kahn v. Lynch, 638 A.2d 1110 (Del. 1994), however, if the controlling stockholder can show either (a) the merger was approved by a well-functioning committee of independent directors, or (b) the merger was approved by a fully-informed, uncoerced vote of the majority of the minority stockholders, then the burden would shift to the plaintiff stockholders to show that the transaction was not entirely fair. Such transactions came to be known as Lynch transactions.
Following a suggestion in dicta by then Vice Chancellor Strine in In re Cox Communications Shareholders Litig., 879 A.2d 604 (Del. Ch. 2005), the Delaware Supreme Court has now held that if both procedural safeguards are adopted, then the transaction will be reviewed under the business judgment rule. More accurately, in the words of Justice Holland’s opinion,
[I]n controller buyouts, the business judgment standard of review will be applied if and only if: (i) the controller conditions the procession of the transaction on the approval of both a Special Committee and a majority of the minority stockholders; (ii) the Special Committee is independent; (iii) the Special Committee is empowered to freely select its own advisors and to say no definitively; (iv) the Special Committee meets its duty of care in negotiating a fair price; (v) the vote of the minority is informed; and (vi) there is no coercion of the minority.
The theory here is that combining a well-functioning independent committee and a fully-informed majority-of-the-minority vote replicates the standard structure for the approval of third-party mergers under DGCL Section 251 (i.e., board vote plus stockholder approval), and so the standard of review should be same as it would be for a third-party Section 251 merger.
Like almost everyone else, I find this a sensible outcome, but I want to note a few important points about the case that seem to have been overlooked in much of the commentary I have thus far seen.
To begin with, the mere shifting of the burden of proof in Lynch transactions, while not negligible, was of relatively minor value to controlling stockholders for two reasons. First, the burden was still on the controlling stockholder to demonstrate that one of the procedural safeguards had been adopted, and this required a significant amount of proof: for example, merely saying that a committee was composed of independent directors did not suffice to show that the directors really were independent. Second, even if the controlling stockholder prevailed on this issue, the standard remained entire fairness, and determining whether the transaction was entirely fair often could not be resolved even at the summary judgment phase. Hence, the controlling stockholder was in for a costly litigation. It may seem that M&F solves that problem, but this is not quite right. Rather, the burden is still first on the controlling stockholder to demonstrate the existence and effectiveness of both of the required procedural safeguards, and although Justice Holland emphasizes that this can sometimes be done at the summary judgment phase, it is easy to imagine that sometimes a trial will be required to determine issues of material fact.
Second, there is to my mind a serious ambiguity in the new doctrine. In the summary of its holding quoted above, the court says that, to receive the protection of the business judgment rule, the independent committee must have fulfilled “its duty of care in negotiating a fair price.” This could mean simply that, in approving the merger, the committee fulfilled its duty of care in accordance with Smith v. Van Gorkom, 488 A.2d 858 (Del. 1985)—that is, before deciding to approve the merger, the committee had before it all the material information reasonably available. On the theory that the standard of review will be business judgment review when the usual conditions to the applicability of that standard have been replicated, it would seem logical that the duty of care demanded of the independent committee be this usual kind of care. But that is not quite what the court said, for it also refers to the committee’s having “negotiat[ed] a fair price,” which may suggest that something more is demanded than “process due care only,” Brehm v. Eisner, 746 A.2d 244, 264 (Del. 2000) (emphasis in original), namely, that the board have obtained a fair price.
That result, of course, would entirely subvert the holding in the case, but the point is not so easily dismissed. Although a freezout merger does not involve a change of control (the controlling stockholder controls the corporation both before and after the transaction), if the merger consideration is cash, as it was in M&F, then the transaction represents the last opportunity for the minority stockholders to get a premium for their shares, and, in fact, such transactions are typically done at a premium. This implicates some of the concerns underlying Revlon: it would seem that, besides reviewing the level of care taken by the independent committee in the decision-making process, the court should also review its actions to determine whether it took reasonable steps to get the best price reasonably available for the minority stockholders. Obviously, the range of reasonably possible actions for an independent committee of a controlled corporation, especially when the controlling stockholder announces it has no desire to sell its shares, is much more limited than the range of actions available to a board of an independent company putting itself up for sale. But, it would still seem to me that the court should review the independent committee’s actions under Revlon, taking account of the limits under which the committee is likely to operate. After all, in a Section 251 cash merger, the court reviews the transaction under Revlon, not just the business judgment rule.
Now, although it does not say that it is doing so, the court does seem to be applying some form of enhanced scrutiny to the actions of the independent committee. Thus, in determining whether the committee acted with due care, the court notes factors of clearly procedural significance (e.g., the number of meetings the committee held, its engagement and use of a financial advisor, etc.), but it also enumerates factors that seem to bear more on the substantive question of whether the committee got the best price reasonably available, including where the deal price fell in the financial advisor’s valuation ranges, the extent to which the company’s business was deteriorating, the fact that the committee was able to negotiate a modest increase in the price, and the committee’s studying alternative strategic transactions (presumably because, even though the controlling stockholder had announced it would not sell its shares in an alternative transaction, such alternative transactions could inform the committee’s decision about the fairness of the price to be paid by the controlling stockholder). The inquiry that the court performs under the label of a due care inquiry seems much like a Revlon review.
Finally, there is the question of how M&F will affect the relative attractiveness, from a controlling stockholder’s perspective, of so-called Siliconix transactions in which the controlling stockholder tenders for all the outstanding minority shares, hoping to get above the 90% threshold so that it can follow up the tender offer with a DGCL Section 253 short-form merger. See In re Siliconix Inc. Shareholders Litig., 2001 WL 716787 (Del. Ch. 2001). In such a transaction between stockholders, both of whom are free to act in their self-interest, the controlling stockholder has no duty to offer the minority stockholders a fair price, providing only that the controlling party makes appropriate disclosure and the tender offer is not coercive. Aside from alleging disclosure violations, there is usually little plaintiff stockholders can complain about in a Siliconix transaction, but since the controlling stockholder has to achieve the 90% threshold to make the whole deal worthwhile, such transactions can be difficult to complete if the controlling stockholder is starting from a relatively low percentage interest in the company or the price being offered is not especially attractive. On these important questions, see the fascinating papers by Subramanian here and Restrepo and Subramanian here.
After a delay caused by the well-publicized attack on Typepad, Robert Miller is poised to begin guest blogging. Robert is Professor of Law and F. Arnold Daum Fellow in Corporate Law at the University of Iowa College of Law, where he teaches Mergers and Acquisitions, Law and Economics, Corporate Finance, Business Associations, Antitrust, and Contracts. He is an experienced and insightful transactional lawyer, and we are grateful to have him for the next couple of weeks at the Glom. Welcome, Robert!
Dealbook has reprinted a series of tweets by Marc Andreessen explaining the sometimes lofty valuations of acquisitions in the tech sector. The key idea is "attach rate," which Andreessen describes as follows: "acquirer Y can attach company X's product to Y's sales engine."
We used to have another word for this idea: synergy.
Just because it's not new doesn't mean it's not real. But Andreessen rightly cautions: "Of course, for the deal to be good, I have to deliver that attach rate. But when it works, and it often does, it's magical & worth doing."
I am probably more skeptical -- "often" should probably be "sometimes" -- but I generally agree with the thrust of the tweets. Thanks to Matt Jennejohn for the pointer.
Up and running in the Caron blog empire is the new Law and Economics Prof blog, featuring a pretty long array of contributors, including Brian Galle, Murat Mungan, David Gamage, Eric Rasmussen, Ben Depoorter, Gerrit de Geest, Shi-Ling Hsu, Manuel Utset, and Yuval Feldman, with others on the way to join, I have it on good authority. An interesting read so far, so do check it out.
A friendly notice about the AALS-Mid-Year meeting on "Blurring Boundaries"...
The AALS Workshop on Blurring Boundaries of Financial and Corporate Law will be held June 7-9 in Washington, DC.
The workshop is designed to explore the various ways in which the lines separating distinct, identifiable areas of theory, policy, and doctrine in business law have begun to break down. The workshop sessions will focus on: research; teaching; complexity; modern regulatory approaches; innovation; competition; and collaboration in international financial markets; and political dynamics. A workshop objective is to bring together law faculty representing a variety of financial and corporate disciplines, scholarship traditions and pedagogical practices and perspectives.
The workshop provides a unique opportunity for faculty members to make connections between their primary fields and other fields in financial and corporate law, making it relevant to a broad spectrum of law scholars and teachers. Law faculty in all business fields should find the workshop useful to their scholarship and teaching.
You may remember Greg Shill blogged about Mr. Gox--at that time I just had some vague, "Mt. Gox-bad-virtual-currency-shady" bitcoin association in my head. Since then, I've heard 2 student presentations on Bitcoin , and I thought I'd pass along what I have learned. Dear reader, I will presume that you, like me, really don't know anything about it. It may well be that in this matter, like so many, I am wrong.
Both presentations started out with this video (It's less than 2 minutes, just go ahead and watch it):
Ok, what struck you? Was it the miners? How bizarre is that? Bitcoin crowdsources its processing of individual transactions to "miners," who earn bitcoins for their trouble. And bitcoin has a built-in limit. From bitcoin.org:
Bitcoins are created at a decreasing and predictable rate. The number of new bitcoins created each year is automatically halved over time until bitcoin issuance halts completely with a total of 21 million bitcoins in existence. At this point, Bitcoin miners will probably be supported exclusively by numerous small transaction fees.
Here is another video that shows a large scale bitcoin miner. This one is longer, and a little local-news cheesy:
I'm now much more interested in bitcoin. Here are some random thoughts:
- I love the "stick it to the man" "down with the banks" angle. No user fees! Fight the power!
- Much to say about the auto-limiting feature. Supposedly it's built into the code. But clearly bitcoins have been hacked before. Who's to say the 21 million ceiling is a unhackable?
- What if it can't be hacked? What does it mean to have a currency that can't be devalued by a government in need of quick cash? Sounds pretty cool.
- How important is anonymity in purchasing? Is it just a drugs and porn thing, or for more mainstream industries?
- What role does/should law have here?
Update: Urksa Velikonja in the comments linked to a great article giving more info about mining. Have miners created securities? Sounds like a great fact pattern...
Also, on the hacking front, here's a link to a chronology of bitcoin hacking incidents. The idea of hackers making off with my virtual wallet has me rocking me back and forth humming and holding my hands over my ears. I don't think I could do more than dabble in the world of virtual currency.
- "That one million hours a year devoted to resolution planning is 500 full-time employees"
- "There are 8,000 employees 'dedicated solely to building and maintaining an industry-leading Anti-Money Laundering (AML) program.' JPMorgan employs more AML compliance officers than the Treasury and the Fed combined."
- Stress testing required 500+ FTEs
- Compliance with Basel's new securitization rules has required 35,000 hours of work (at 2000 hours per year, that's only 17.5 FTEs, so you can see why they moved to hours there).
That's a lot of compliance, and indeed, at these rates, way more people do compliance for JPMorgan than, probably, do actual investment banking. Of course, maybe we want all of this given that the firm is far too big to fail, and maybe we want to make banking burdensome and unprofitable. If so, we are on our way!
The DC Circuit rather shockingly threw out the SEC's conflict minerals rule ONLY because it compelled publicly traded companies to speak about the issue in their securities filings, which it concluded violated the First Amendment. EDIT: This means that the parts of the rule that require reporting but not a statement that goods are "not DRC conflict free," might still be okay. Bainbridge has takes here and here, Jonathan Adler here, Matt Levine here.
But, you are thinking, the SEC compels companies to do a million things in their securities filings! Does the very existence of a disclosure regime violate the First Amendment? The court's novel theory was that it is okay to mandate disclosures that aim to prevent consumer deception (so the books of publicly traded companies could be opened to investors), but any other goal must have more than a rational basis to be sustainable.
It is a crazy theory. Warning labels, origin labels, nutrition labels, mandatory agricultural marketing schemes, they don't involve consumer deception, and they're okay. And maybe this reveals a lack of adoration for the First Amendment, but if Congress could prohibit companies from using conflict minerals, which it surely can, then requiring them instead to disclose the use is both less burdensome and possibly more efficient. Why would we want a legal system that does not permit disclosure regimes, thereby requiring command and control?
Some other observations:
- One judge wanted the court to wait for a ruling in a related case going en banc before the now democratically controlled circuit, and the two majority judges declined to do so because now the SEC and the petitioners could participate in the en banc. Unless the new Obama judges on the court cannot hear the en banc, this seems like a request for a quick reversal.
- Also interesting, the court didn't bullet proof the opinion. The SEC survived the adlaw challenges, and the very controversial cost-benefit analysis requirement the DC Circuit has started imposing, though that is likely to change very soon, on the agency. There is only one ground for reversal here: disclosure is unconstitutional.
- There is a difference between speech and conduct in the First Amendment, but the other big thing the SEC does in foreign policy is corrupt practices prosecutions (bribes paid to foreign government officials, that is). Could that be affected by the holding of this opinion, were it to stand? It sure isn't consumer protection.
- One of my many pet theories about why people care about constitutional law, though they often overdo it, is the sense that stare decisis is only sort of a good way to think about the subject. Conservative judges clearly love commercial speech, and have been using it to reverse some settled doctrines that have been in place for decades. I doubt a single securities lawyer thought that this was a plausible holding by the Court. Some smarter on the subject than I were clearly surprised. Let's see if it lasts.
I really enjoyed this conference! One of the best parts about it was that it threw together people who think quite differently about corporate law. One of the great things about Steve Bainbridge is his openness to critics and his genuine desire to engage in a conversation with opposing viewpoints. Most people just want to hear that they're right. Steve doesn't, and that's a rare thing in this business.
As is often the case, as the panels unfolded a thought kept percolating in my mind and never made it to a question. Luckily, I'm a blogger, so I can keep talking!
In the first panel proponents of the director primacy, shareholder primacy, and team production model made their case. The next panel critiqued them, and yours truly was tasked with Steve Bainbridge's director primacy. One concern I voiced about both team production and director primacy it that they don't map on to closely held corporations particularly well. Both Blair & Stout and Bainbridge generally concede this point, focusing on public corporations.
But whenever Steve starts his director primacy riff, he says that he set out to explain the Delaware code as it is. And the Delaware code, as I remind my BA students when we move to the close corporation setting, doesn't consist of a "public corporation" law and a "private corporation" law. It's just corporate law--with the weird and relatively seldom used statutory close corporation provisions thrown in. So if you start with the code you have to deal with that basic point--it's the same code for private and public corporations--shouldn't your explanatory theory explain both?
The next panel talked about implications for corporate purpose, and we got to talk hot-button Supreme Court cases. Margaret Blair said something I'd been thinking for a while. Part of what bollixes up the Court is this same one-size-fits-all corporate form. Hobby Lobby is a big corporation, but it's a private corporation. The Justices talk about a little kosher or halal slaughterhouse which we all know is different from a large publicly traded corporation. Yet it's the same form and the same law. Why? I suggest to my students that it's because states, most pointedly Delaware, find more value in a large bank of corporate law precedents than in having categories of corporations to which different laws apply. That is, if Delaware is marketing its rich corporate case law as part of its competition for corporate charters, it's not going to want to divide up its precedents into close corporation law versus public corporation law. Divide and suffer, precedentially speaking. But this "one law" approach causes problems because we know, intuitively and as a matter of reality, that public and private corporations are different.
Citizens United is even more problematic, because there you do have a different code, and actually a different organizational form--the nonprofit. As I wrote in Entity and Identity, form matters. A nonprofit corporation is quite different from a for-profit one, and according a non-profit certain speech rights doesn't necessitate the same for a for-profit.
These nuances get elided, though, if you lump everything together as a "corporation." And, of course, the corporate codes--Delaware and the Model Act--are guilty of that on the public/close corp front, if not on the for/nonprofit one.
"Let's get together and feel all right" is a great plan for a conference (thanks again, Steve!), but does it work as well for corporate law?
I took a look at a panel at the American Society of International Law and wrote up some thoughts in an ASIL Cable. A taste:
The [UN Guiding] Principles [on Business and Human Rights] are an achievement and an agenda setter, but the text – that “states must protect against human rights abuse within their territory and/or jurisdiction by third parties, including business enterprises,” and that “business enterprises should respect human rights” – is hardly specific. And indeed, if a theme was running through the views of the panelists, it was that the guiding principles achieved progress as part of a palette of incentives. These could induce businesses to think about, say, resettlement practices where large public works and mineral extraction projects were being pursued, worker and other protections could be built into supply contracts to ensure that the groups most affected by large investments should be able to profit from those investments.
Do give it a look.
Today I am excited to be flying cross-country to attend a Conference and Micro-Symposium on Competing Theories of Corporate Governance at UCLA Law, organized my my friend and Friend of Glom Professor Steve Bainbridge.
A "micro-symposium," for those not in the know, means that you write 750 words on the subject at hand. Which was a challenge, but also a lot of fun.
Looking forward to a great conversation about shareholder primacy, director primacy, and team production!
I love the Marvel superheroes. And my favorite superhero is Captain America. So, our family was in a sold-out IMAX theater on Friday night for Captain America: The Winter Soldier. Earlier that day, I had purchased a certain someone the winter soldier action figure at the Disney store. This actually caused some problems in our household because the box names the winter soldier as Bucky Barnes. My daughter looked at me like I just told her there was no Santa Clause. "The winter soldier is Bucky!?" So, sorry for the spoiler.
The plot of this sequel is fairly hard to describe without giving away more than the identity of Bucky. Suffice it to say that in the first part of the movie we find out that S.H.I.E.L.D. has been compromised. Captain America has to figure out who is not corrupt, who he can trust. Then, they will have to save the world from the enemy. Black Widow plays a very large part in the movie (foreshadowing her own movie?), and a new superhero is introduced, Falcon. Robert Redford appears as Alexander Pierce, S.H.I.E.L.D. agent and leader of "the council" that gives Nick Fury orders regarding S.H.I.E.L.D. My favorite part was when Pierce opens his super-fancy refrigerator, with a glimpse of Newman's Own pasta sauce. (I'm sure lots of zillionaires keep leftover pasta sauce in their fridge, but whatever.)
The bad guys (who shall not be named here) have a secret weapon, Bucky, who also has some of whatever makes Captain America so super. He may even have a little more. Bucky has no memory of who he was at all. In a way, this movie taps into the angst of returning U.S. soldiers from Iraq and Afghanistan -- Falcon runs a support group for vets having trouble assimilating back into civilian life, and he empathizes with Steve Rogers, who is having trouble assimilating after returning from a war seventy years ago to a time and place that is foreign to him. Not to give it away, but Steve's only soulmate is 96. Bucky is an extreme version -- told by the bad guys that he is a soldier making the world better for humanity, but who is being used and exploited for the bad guys' own ends. (Remember, one of the big plot points for Iron Man 3 was that Tony Stark has PTSD from his battle with Loki's alien army.)
The biggest hole in this movie, just like in Iron Man 3, is WHY DOESN'T CAPTAIN AMERICA CALL THE OTHER AVENGERS? If the fate of the world is really hanging in the balance, and you have three friends with whom you've saved the world before, why wouldn't you call them? At least call Tony Stark. From a plot point of view, the absence of the other Avengers in these sequel is unbelievable. From an actor contract perspective, it makes sense. Robert Downey, Jr. has fulfilled his contracts. That is a negotiation for done the line. Also, once you start calling in help, the sequel just becomes Avengers2. But back in the world where millions of people are about to die, it seems weird that Captain America doesn't ask Black Widow what Iron Man is doing for the next few days.
Still, it's an awesome movie.
The leverage rule agreed to internationally is 3%, and you should think of a it as an alternative minimum tax. Worried that banks might be able to game capital requirements, which require them to hold funds in reserve to deal with shocks, the world's regulators also decided to forbid, on pain of cutting dividends and executive compensation, large banks froms from taking positions that would mean that more than 3% of their assets are capital. American banking regulators are going further - they are disincentivizing bigness by requiring the 8 largest banks to comply with a 5% leverage ratio. Some thoughts:
- The giveback to industry is that this rule isn't effective until 2018. Only in financial regulation do you ever see such long-dated rules.
- American banks might have to add $68 billion in capital to comply with this requirement. Would you sue to avoid that kind of a charge? Of course you would! But the banks probably won't. The Fed just doesn't face the sort of Total Litigation regulatory contest that the SEC faces.
- Ditto, you'd think that such a big deal rule would require review by OIRA. Nope!
Haskell Murray and Anne Tucker recently blogged quite engagingly about their Fear of Missing Out (FOMO). They made me feel old--not only because of these newfangled acronyms, but also because I remember feeling that way myself. I found particularly brave their articulation of the suspicion that they weren't "good enough" and had somehow lucked into the job. I remember feeling that way, too, and I have a sneaking suspicion that there are 2 kinds of junior faculty members: 1) those who think they're not really as smart as everyone else, and 2) those who really aren't as smart as everyone else. "Arrogance" is just a few letters away from "ignorance."
But I digress. I remember feeling this way, and I had a mentor give me excellent advice my first year:
Just say no.
At least, your default answer should be "no." To my chagrin, I realized something at the end of my first year of teaching: This job has infinite demands. There are 3 elements to it: teaching, scholarship, and service. You could devote every waking moment to your teaching, and still have more you could do. Ditto for service. Ditto to the nth degree for scholarship: always another talk you could attend, an article you could read. But you can't do those things and write. At least, I can't. You have to get used to always feeling like there's more you can do. You'll feel guilt, but you have to make your peace with it.
I set boundaries for myself, like trying not to travel more than once a month while classes are in session. But the best piece of advice I got was that your default answer should be "no."
P.S. Haskell, I'd love for people to think that I'm some kind of superwoman, but that was my schedule for a brief period of my life. Baby #3 started sleeping through the night at about 6 months. Hallelujah!
The answer is no, it won't kill monetary policy, but here's the way it might constrain the Fed, which relies on primary dealers (that is, big banks, who would now be subject to leverage requirements) to help it set the federal funds rate. This reliance has been cited as a reason to delay the leverage rule. Felix Salmon also thinks that's no reason to delay the imposition of the rule, but here's how the argument works, in his nicely straightforward words:
The way that the Fed conducts monetary policy is by instructing the traders at the New York Fed to buy and sell certain financial instruments so that a particular interest rate — the Fed funds rate — is very close to a certain target. Through a complex series of financial interlinkages, setting the Fed funds rate at a certain level then has a knock-on effect, and ultimately helps determine every interest rate in America, from the Treasury yield curve to the amount you pay for your credit card or your mortgage.
Those interlinkages are so complex that they’re impossible to model with any particular accuracy: all the Fed can do, really, is set the Fed funds rate and then see what happens to everything else. And directionally the causality is clear: if the Fed wants rates to rise, then it pushes the Fed funds rate upwards, and if it wants rates to fall, then it brings the Fed funds rate down. That doesn’t always work at the distant end of the yield curve, but it’s still most of what monetary policy can do.
Especially early on in the chain, a lot of the interlinkages take place at the level of big banks. And so it stands to reason that if you change the leverage requirements of big banks, that might change what happens to interest rates when you move the Fed funds rate.