I’ve been fascinated by the battle over the Tribune Publishing Company, because it’s a fairly stark example of directors’ obligation to maximize shareholder wealth conflicting with the broader interests of society, and is a textbook case for M&A classes.

Tribune Publishing has a troubled history, but was managing to turn a profit; Alden Global, a hedge fund with a 32% stake in the company, offered to buy out the remaining shareholders at a premium of around 35% (compared to the stock price prior to the announcement of its offer).  Alden, owner of several newspapers, is known to run them ruthlessly, selling real estate, making significant cuts to newsrooms, and causing local coverage to suffer.  The macro consequences are significant: as local news declines, corruption grows and services to residents are reduced.

That said, Alden’s papers have profit margins of about 17%; by contrast, the New York Times’s profit margin is 1%.  From a fiduciary duty standpoint, the Tribune Board’s obligation here was a no-brainer; it was unlikely that any kind of long term plan would give shareholders as much value as Alden’s offer.

Reporters at the Tribune papers, of course, protested, but that was Alden’s problem, not the Board’s: if reporters chose to revolt over the sale, maybe even to the point of damaging the properties, the Tribune shareholders would still be cashed out and laughing all the way to the bank.  Delaware offered no space for the Tribune Board to worry about the broader impacts of the sale on newspaper quality.

Enter Stewart Bainum Jr, a wealthy hotel magnate who wanted to buy just the Baltimore Sun and run it as a nonprofit – I gather on a model similar to the Salt Lake Tribune.  But he felt he had been betrayed in negotiations by Alden, and instead decided to make a bid for the whole company.  He joined with another billionaire, Hansjorg Wyss, to tentatively top Alden’s bid, which allowed the Tribune Board to share confidential information under the merger agreement.  However, Wyss was not as altruistically-minded as Bainum; once he saw the financials, he dropped out, apparently because he realized the Chicago Tribune would never be a national paper.  Bainum was unable to put together a new bid, and shareholders voted in favor of the deal yesterday.

But there was one bit of last minute intrigue.  Patrick Soon-Shiong, the billionaire owner of the Los Angeles Times, held a 24% stake in Tribune, and he alone could block the sale because the merger agreement required two-thirds approval by the non-Alden shares.  If he voted against it, the deal would be sunk.  A few days ago, he told the Washington Post – improbably – that he had forgotten the shareholder meeting was set for May 21, and hemmed and hawed over how he planned to vote . 

The day of the vote, he released a statement that he would “abstain” because he was a “passive” investor in Tribune – as though anyone could be passively invested while owning 24% of a high profile public company.

More importantly, he didn’t really abstain – he simply submitted a blank proxy card, and the Board voted his shares in accord with its recommendation, i.e., in favor of the sale.  This initially caused some confusion in the reporting, because the proxy statement instructions distinguished between blank proxy cards submitted by shareholders of record, and blank proxy cards submitted by beneficial owners (i.e., holders in street name):

If you are a stockholder of record and you return your signed proxy card but do not indicate your voting preferences, the persons named in the proxy card will vote the shares represented by that proxy as recommended by the Board of Directors. If you are a beneficial owner and you return your signed voting instruction form but do not indicate your voting preferences, please see “What are ‘broker non-votes’ and how do they affect the proposals?” regarding whether your broker, bank, or other holder of record may vote your uninstructed shares on a particular proposal.

The proxy statement later explained that broker non-votes were, functionally, votes against.  Soon-Shiong, with his large stake, was a record stockholder, and so his blank card was a delegation of voting power to Tribune’s Board – a vote in favor – despite his claim of abstention.

Why, then, did he not simply vote for the deal?

I assume because reporters across the country have been concerned about this sale for months – including reporters at Soon-Shiong’s LA Times.  If he voted in favor, he would potentially have sown distrust in his own newsroom, and he thought he could square that circle by appearing to take no position.  But taking no position wasn’t really an option for him: given the two-thirds voting requirement, if he had truly abstained, so that his votes simply weren’t counted one way or another, that would have been enough to block the deal.  Even choosing not to decide would have been a decision.

Or is that really true, though?  Because there was a third option available.  He could have chosen echo voting – voting his shares in exact proportion to the votes of the other non-Alden shareholders.  That would not have had no effect – his mere presence would have made it possible for Alden’s bid to succeed – but he would have delegated his decisionmaking to the other shareholders, which would have been a much more “passive” move than delegating it to Tribune’s Board.  We don’t have the exact vote count yet, but apparently around 81% of the non-Alden shares voted for the deal.  If that’s right, it means with echo voting, the vote probably would still have favored the deal, but it would have been a squeaker.  I look forward to seeing the final totals.

PIABA and the PIABA Foundation recently released a new study on stockbroker expungements within the FINRA forum. Their review of arbitration awards finds that FINRA’s arbitrators continue to recommend expungement around 90% of the time.  This doesn’t surprise me.  The entire system seems fundamentally broken and these expungement requests almost never receive any real scrutiny because there are no adversaries for most expungement requests.

FINRA has a pending proposal with the SEC which will make some changes to the process.  It’ll increase the number of arbitrators hearing these cases, eliminate the ability of parties to rank and strike arbitrators (which may reduce selection effects toward arbitrators who simply grant expungements), and create more procedural rights for non-party customers to participate in the hearings.  I’ve commented on the proposal twice and FINRA has amended it twice. 

There are different ways to look at this.  One way is that the process is gradually getting better.  There is some truth to this.  The changes will make the panels a bit more balanced and may make it easier for non-party customers to participate in these hearings.  That being said, many of the FINRA rules specify that “parties” have particular rights in these proceedings.  What rights non-parties have will always be contested.  Consider one problem we recently ran into.  I took a team of UNLV Law students and opposed two different expungement requests on behalf of non-party customers last semester.  The second case involved a widow who had lost hundreds of thousands of dollars over a decade ago.  About a decade ago and shortly after her husband died, the case settled for hundreds of thousands. 

In 2020, the stockbroker sought to expunge several customer disputes.  The broker’s counsel transmitted notice to the widow roughly thirty days before the scheduled hearing.  The widow was disturbed by the allegations that she and her late husband had made false claims.  Although she did not desire to subject herself to a demeaning hearing where she and her late husband would be called liars, she asked the Clinic to appear on her behalf and contest the expungement. We made two main arguments:  (i) the matter wasn’t eligible for arbitration because of how much time had passed; and (ii) that the customer dispute information was accurate and did not merit expungement.

The eligibility argument is straightforward.  FINRA Rule 13206 provides that “No claim shall be eligible for submission to arbitration under the Code where six years have elapsed from the occurrence or event giving rise to the claim.” If you measure the “occurrence” from the underlying settlement date, it seemingly falls well outside of FINRA’s eligibility period. Counsel for the broker argued that the panel should not take any notice of the widow’s eligibility-period argument because FINRA rules only specify that “Parties” may make motions to dismiss. 

This brings me back to the pending FINRA rule proposal.  The changes will likely do some good, but anytime the existing FINRA rules speak in terms of “parties,” stockbrokers will argue that non-party customers should not be able to make use of those rules.  Although the process may improve to a degree if the SEC approves the proposal, these sorts of gaps and barriers will remain because the non-party customers are not parties.

In reality, these are not ordinary disputes between parties.  These arbitrations are really about non-parties to the dispute:  (i) whether the non-party customers made a “false” claim; (ii) FINRA’s requirements that firms impose heightened supervision on brokers with strings of complaints; (iii) state regulators keeping a closer eye on brokers with histories of problems; (iv) potential future customers avoiding brokers with a history of problems; and, (v) cleaning up a broker’s record because past customer disputes may be taken into account in another pending arbitration.  Purging these records is really about taking information away from non-parties.

The other way to look at the proposal is that it just won’t alter the fundamental problems with the process.  The arbitrators deciding these cases are not making well-informed decisions because there is little incentive for anyone to provide them with information opposing granting expungement.  Even with the changes, there isn’t a good reason to believe that the arbitrators will make well-informed decisions here.  Although it will be easier for customers to participate should they want to do so, the pending changes don’t create any reason why non-party customers would want to subject themselves to the process. Unsurprisingly, they have not participated.  We shouldn’t expect them to participate in the future.

Vice Chancellor Zurn just issued a monster, 213-page opinion sustaining a complaint alleging that the Board of Pattern Energy breached its fiduciary duties when selling the company.  At 213 pages, there’s a lot to talk about, but I actually am going to focus on a couple of specific points that happen to intersect with a lot of what I blog about here.

The set up:  Pattern Energy was created by a private equity firm, Riverstone, to operate energy projects owned by other Riverstone entities.  At one time, Riverstone indirectly owned a controlling stake in Pattern, but by the time of the events of the complaint, it had shed its interest.  It did continue to exert influence, though.  First, Pattern had been formed to operate other Riverstone projects, and continued to do so, mainly though its relationship with another company called Developer 2, which was majority-owned by Riverstone.  Second, Pattern owned a stake in Developer 2, but was prohibited from selling that stake – including through a merger – without Riverstone’s consent, which functionally gave Riverstone approval power over Pattern mergers.  Third, most of Pattern’s officers, including its CEO, were Riverstone affiliates and partners in various ways, including by occupying present or past managerial roles with Developer 2.  Fourth, two of Pattern’s directors were Riverstone people – its CEO, and a Riverstone manager who had been appointed to Pattern’s board back when Riverstone had hard control.

According to the complaint, Pattern began contemplating a merger, and because of its close ties to Riverstone and especially Developer 2, Riverstone wanted to make sure that any merger would preserve Riverstone’s influence and Pattern’s relationship with Developer 2.   Therefore, Riverstone preferred a financial buyer who would maintain Riverstone’s role with the companies, and was opposed to a strategic acquirer, Brookfield, who would pay more for Pattern but would either also absorb Developer 2 or disentangle it from Pattern.  The plaintiff alleged, and Zurn accepted, that Pattern’s Board favored the financial buyer over Brookfield, largely to protect Riverstone, in violation of its duties to maximize wealth for Pattern’s stockholders.  Zurn also sustained certain claims against Pattern’s officers, and aiding-and-abetting claims against Riverstone.

So here’s what I find most interesting….

(More under the jump)

Continue Reading Controllers, Disinterested Stockholders, and Pattern Energy

Nevada’s Supreme Court recently released a new business law decision.  It arose out of AMC’s acquisition of RLJ Entertainment (RLJE), a Nevada corporation.  Back in 2016, AMC  loaned RLJE $65 million in exchange for the option to become a controlling stockholder by acquiring 50.01 percent of RLJE’s stock.  That deal prohibited RLJE from shopping any acquisition proposal and also let AMC designate two directors on RLJE’s board.  Later, in 2018, AMC offered to purchase RLJ’s outstanding shares at a price of $4.25 a share.  RLJE formed a special committee to negotiate.  The special committee negotiated over about 50 days and eventually secured an offer at a a price of $6.25 a share.  The merger was approved at a stockholder meeting held on Halloween.  

Shareholder plaintiffs sued, pointing out that certain directors were interested parties in the transaction.  Notably, they also conceded that “the two members of the Special Committee, Laszlo and Royster, ‘had no commercial, financial or business affiliations or relationships with any of AMC, [ ] Johnson or any of their respective affiliates.'”  

Under Delaware law, this sort of controlling shareholder acquisition would likely have been subject to entire fairness review without both approval by independent directors and a majority vote of minority stockholders.

Nevada did not follow Delaware here.  The trial court dismissed the suit under Nevada’s statutory business judgment rule, explaining that establishing liability under Nevada law “plainly requires the plaintiff to both rebut the business judgment rule’s presumption of good faith and show a breach of fiduciary duty involving intentional misconduct, fraud, or a knowing violation of the law.”  

Sullivan and Cromwell’s John Hardiman appeared in the case and explained Nevada’s relevance for corporate law, writing:

With Guzman, the Nevada Supreme Court has affirmed that its statutory business judgment rule, not the “inherent fairness” standard, is the sole standard for any analysis involving fiduciary duty claims against corporate directors and officers in Nevada. As such, plaintiffs seeking to survive a motion to dismiss must allege that directors and officers breached their fiduciary duties and engaged in intentional misconduct, fraud, or a knowing violation of law. The Court also has made clear that these standards are not automatically satisfied simply because a transaction was done with a controlling stockholder. Instead, a case can be dismissed against the board and the controller where the board’s statutory presumption of good faith has not been overcome and the controller has not actively exercised its control. Thus, this decision departs significantly from current Delaware law, which imposes an entire fairness burden on both the board and controller accused of self-dealing and only applies the business judgment rule in transactions with controlling stockholders when the transaction at issue is (1) negotiated by a properly functioning and empowered independent committee of the board and (2) subject to a free of coercion and fully informed majority-of-the-minority vote.

Nevada has positioned itself to rival Delaware in new corporate registrations, and Nevada courts therefore may continue to develop into an increasingly significant forum for corporate governance disputes. To that end, the Guzman Court stated that its decision affirming the statutory business judgment rule sought to give effect to the “straightforward” language in NRS 78.138 and to adhere to the “purpose of NRS Chapter 78, which is ‘for the laws governing domestic corporations to be clear and comprehensible.’”