Thursday, March 30, 2006

Old Battles and New Attacks: On the Road to Waterloo

Dale A. Oesterle
Special to

The August 2005 issue of the Business Lawyer, the American Bar Association, Section of Business Law publication, contained an article by Martin Lipton of Wachtell, Lipton, Rosen & Katz entitled "Twenty-Five Years after Takeover Bids in the Target's Boardroom: Old Battles, New Attacks and the Continuing War."

It was a self-congratulatory piece but worth attention nonetheless for its effort to set the stage for future policy initiatives from the board-dominance camp. Martin Lipton is soon to meet his Waterloo.

In the opening of the piece, Lipton declares victory over hostile tender offers. State anti-takeover legislation and state court sanction of poison pill plans, the most potent of which Lipton invented, gave target boards control over tender offers. Hostile tender offers, tender offers that can close in the fact of target board disapproval, are dead. Tender offers that may still start hostile must close friendly; a hostile offer is now a mere bargaining tactic to convince the target board to assent.

"That battle was won. But there is little rest for the battle-weary ... new, and perhaps more dangerous, battles await us," laments Lipton. At stake, he exhorts, is "American enterprise ... the systematic risk-taker and risk-sharer of our economy -- the primary means through which wealth and prosperity are generated ... " He concludes with a call to arms: "We must do all we can to ensure that the train does not fly off the tracks." Whew.

What is this new awful threat? Shareholders' exercise of their voting rights.

To understand the claim, we need some history. In the '80s, shareholders in publicly traded corporations had, at minimum, two rights -- the right to sell their shares and the right to vote their shares. When hostile tender offers threatened incumbent managers, shareholders lost the right to sell their shares absent target board approval. This loss of power to alienate shares came in most cases without a shareholder ratifying vote.

Courts that sanctioned the loss accepted Lipton's claim that boards run corporations but with a reassuring caveat -- shareholders could always vote out the board. Lipton and his clients did not worry much because insurgent proxy contests were, at the time, expensive and very hard to win.

But times have changed. The Internet, a steady loosening of Securities and Exchange Commission rules and coordinated hedge fund activity now mean that proxy contests are easier to wage and easier to win. With the Internet, for example, an insurgent may eventually be able to file and distribute proxy materials and even collect votes online. Indeed, hedge funds that merely threaten proxy contests often have their requests for corporate action respected by sitting boards.

Moreover, shareholders have successfully lobbied corporations for bylaw changes that affect board elections and structure. The most popular shareholder resolution is a simple request that a corporation not seat a director who does not get a majority vote of the shareholders voting. It is hardly a radical request. The shareholder proposals have Lipton seeing red ("dangerous ... over-engineering").

So now Lipton must attack the shareholder voting franchise in addition to the shareholder right to sell her stock. And so he does. Lipton declares that "special interest 'gadflies' ... [shareholders will] seek to conquer the corporate boardroom with their personalized agendas ... without consideration, perspective or even interest in the long-term interest of the corporation and its shareholders as a whole."

In other words, we are going to see an attack on proxy contests and shareholder resolutions by incumbent management ("main street") and their lawyers. They will attempt to roll back the clock to the days when proxy contests were expensive and difficult. Several techniques will be tried, and state courts, state legislatures and the Securities and Exchange Commission will be lobbying targets.

The arguments in favor of restricting shareholder voting will take one or both of two forms. First, some shareholders are better than others. The fast money hedge fund types are inferior to those who hold shares for the "long-run." Second, shareholders are only one constituency of several in a corporation (others are employees, customers, local communities), and the board should consider all constituencies when it makes a decision.

The first argument has to take the position that shareholders who vote a majority of the shares should be disregarded. Hedge funds only win, like anyone else, with a majority. The second argument sees the corporate board as a quasi-government entity with various constituencies. The problem is that at present only shareholders vote; the other constituencies do not. Pushed down its logical path, the argument supports neutralizing the existing voting structure that favors shareholders -- either all constituencies receive the right to vote in board elections or no one votes at all and the board picks its own successors (the not-for-profit model).

Neither of these arguments is going to fly. Lipton, in attacking the shareholder voting franchise, is on the road to his Waterloo. He sold out to shareholder democracy to beat tender offers, and the chickens are coming home to roost.

The simple truth is that investors should be able to choose where they put their money and folks soliciting their money should be able to offer various alternative business structures to attract it. Government rules (be they corporate codes, securities acts and rules or tax laws) that favor inalterably one business model over others and limit investor choice should be minimized.

A graduate of the University of Michigan Law School, professor Dale Oesterle is a nationally recognized corporate law scholar. He has a particular expertise in mergers and acquisitions and has authored a leading casebook on that subject. He practiced law and served as a federal law clerk before beginning teaching at Cornell Law School. He is the J. Gilbert Reese chair in contract law at Ohio State University.'s ongoing LEGAL MINDS article series highlights opinion and analysis from our site's contributors and writers across the ALM network of publications

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