November 8, 2010
Stealth and Ambush Equity Accumulation: Use of Synthetic Ownership Arrangements Pose Dangers
Below is some analysis taken from this Wachtell Lipton memo by Adam Emmerich and William Savitt:
We have recently witnessed equity accumulations on both sides of the Atlantic that were first announced long after they began and long after the acquiring parties had effectively passed applicable disclosure thresholds. Here in the U.S., Pershing Square and Vornado earlier this month announced a combined stake of almost 27% in J.C. Penney. And last weekend French luxury-goods conglomerate LVMH announced that it had amassed a previously undisclosed stake in excess of 14% in Hermès, including through transactions extending over a period of years. Although the details of both accumulation programs are as yet not fully known, they appear to have been conducted on the assumption that the U.S. and French regulatory regimes requiring prompt and current disclosure of share accumulations can be evaded through derivatives and other synthetic and structured ownership arrangements, even when they involve ownership of actual shares by counterparties, up until the point when such trades are settled by taking options on or physical delivery of the underlying shares.
We have long warned of the dangers that new uses of swaps and other equity derivatives, securities loans, and stock purchases timed around record dates can pose to the fairness and transparency of equity securities markets, the legitimacy of corporate elections, and the appropriate interests of public companies and their shareholders in knowing who their shareholders are and when a significant stake is being accumulated.
Despite a number of widely reported situations in which derivatives and other non-conventional ownership arrangements and control devices have been exposed as manipulative and improper (including the battles for control of CSX in the U.S. and Continental in Germany, Sears Canada, and the Porsche – Volkswagen affair, among others), despite moves by regulators in the U.K., Germany, Australia and elsewhere to tighten the rules governing the nature and timing of beneficial ownership reporting and the inclusion of derivatives and other unconventional ownership arrangements in those reporting regimes, and despite the public recognition by the SEC of the need for additional rulemaking and regulation in this area in the U.S., there has as yet been no substantive change in the U.S. reporting and enforcement environment. The J.C. Penney and Hermès situations demonstrate that the current legal and regulatory environment is not adequate to the task without both renewed focus and reform.
While we believe that abusive and misleading accumulation techniques are not immune from liability under existing rules and precedents dating back to SEC v. First City Financial, we continue to urge regulatory reform to definitively close the door on such techniques. However, unless and until lawmakers and securities regulators in the U.S. adopt disclosure requirements in accord with what is now the global consensus towards full and fair disclosure of equity derivatives and other synthetic and non-standard ownership and control techniques, U.S. corporations are well advised to adopt such self-help measures as are available.
These include appropriate provisions in by-laws, rights plans, and other arrangements with change-in-control protections, to ensure that the purposes served by existing arrangements are not subject to being undermined by non-traditional ownership and corporate control arrangements, and to encourage adequate and timely disclosure of actual and synthetic share accumulations for the benefit of markets, shareholders and corporations.