If you own stock in a company that announces it’s being acquired, and you think the acquisition price undervalues the company, there are three things you can do about it: you can vote down the deal, you can find or propose an alternate deal, or you can sue. No I’m kidding of course you can’t do any of those things: you don’t have enough shares to vote down anything, you don’t have the money to propose something else, and you aren’t a plaintiff’s lawyer (are you?) so you aren’t in the business of suing companies, which turns out to be the sort of specialized skill you can’t just acquire in a fit of pique. Those are the tools, but they can only be wielded by specific people.
Steven Davidoff has a delightful piece in DealBook today about the state of the M&A lawsuit market and it is sobering reading:
[L]ast year, 92 percent of all transactions with a value greater than $100 million experienced litigation. The average deal brought five different lawsuits. In addition, half of all transactions experienced multi-jurisdictional litigation, typically litigation in Delaware and another state.
Left out of that description is what percentage of last year’s mergers were agreed to by lazy corrupt self-dealing boards of directors who were putting their own interests above those of shareholders. I submit that it’s strictly between 0 and 92%.
Take the recently announced buyout of Dell. There are already 21 lawsuits pending in Delaware Court of Chancery, and three more pending in Texas state court.
Meanwhile, in another part of town, someone else thinks that the Dell buyout is bullshit, and is actually doing something about it. Davidoff goes on:
Those in favor of such cases argue that though many of these suits may be unsuccessful or minor, they finance litigation against larger deals that need to be challenged and are successful. For example, the litigation over the Del Monte buyout yielded an $89 million settlement, while the litigation over the sale of El Paso yielded a $110 million settlement. For lawyers to bring good cases like these, they need to bring bad ones to pay for them (and because frankly at the start they can’t tell the difference).
And in any event, the bad ones are not that costly. In our report, Professor Cain and I found that 88.5 percent of settlements in 2012 were for disclosure only. The median amount that the plaintiffs’ lawyers earned per settlement was about $595,000. That excludes what defendants had to pay their own lawyers, but some would argue that these costs are reasonable to defray the costs of larger cases and to keep the market on its toes.
That is an amazing economic model. A “disclosure only” merger settlement basically means that the lawyers and the company agree that there will be no change in the deal terms, but that the company’s lawyers will add a few sentences to the merger proxy saying obvious things like “oh by the way our bankers got paid for giving us a fairness opinion” or “of course if we didn’t do this deal there’s some possibility we’d find a massive pile of diamonds under our headquarters and be really rich,” and that will be that. Shareholders would have voted overwhelmingly for the deal before the disclosure, and they vote overwhelmingly for the deal after disclosure, but meanwhile the lawyers supposedly representing them clip a $600K fee.1
In other words, these are cases that the plaintiffs’ lawyers lost: they bring the cases, no one can find any wrongdoing, and so the deal goes forward without any substantive modifications. But the company can’t say “fuck off, we’ll see you in court” because they’re too risk-averse: paying $600K to lawyers to make them go away is better than running even a 0.01% chance of a judge halting a multibillion-dollar merger a week before it’s supposed to close.
But speaking of risk-averse! The model appears to be that paying plaintiffs’ lawyers for bringing losing cases is what keeps them afloat so they can bring the occasional case that, purely by luck, does uncover misbehavior and conflicts of interest that result in payments to shareholders. Rather than relying on a portfolio effect – you lose some money on the losing cases, but make up for it by winning a lot of money on the winning cases – the M&A lawsuit model seems to be almost the opposite. The losing cases pay for the winning ones. And 90% of cases are losers.
The contrast with oh say Carl Icahn’s methods is pretty stark. Sure he doesn’t win every fight he gets involved in, but he also doesn’t get involved in every conceivable fight. He has incentives to keep his batting average up because, if he gets involved in a situation and loses, the consolation prize is not a six-figure fee for some boilerplate writing, but a large loss of actual money that he’s invested.
Most importantly, though, Carl Icahn is looking for situations where companies are actually selling too cheap. That is the main harm that can actually occur to shareholders: if there’s an undisclosed conflict of interest that doesn’t cost them money, they are unlikely to take serious offense. (They are mostly robots anyway.) Plaintiffs’ lawyers are looking for something else: disclosure problems, conflicts of interest, CEO-and-director chumminess, bidder favoritism, and various other shady-looking things that might or might not correlate with a too-low deal price. Dell has some elements of shadiness – mainly, a founder and CEO offering to take private a company with likely more insight into that company’s future than the average public shareholder – but it’s also bent over backwards to check all the procedural boxes – independent committees, go-shops and the like – to make sure it can withstand lawsuits. Twenty-four lawsuits may have been filed, but they were pretty light on smoking guns.
But who cares? Disclosure and conflicts and chumminess aren’t what’s at issue for Dell. $13.65 a share is what’s at issue. Carl Icahn, and Southeastern and T. Rowe, might argue about Dell’s disclosure if it helps them, but that’s not how they’ll win. They’ll win if they can convince shareholders and/or the buyout group that Dell is worth more than $13.65 a share, and the most promising way to do that is by offering more than $13.65 per share in value. Which shareholders would appreciate a lot more than they would some extra disclosure to not read.
Debating the Merits of the Boom in Merger Lawsuits [DealBook / Steven Davidoff]
1. Oh also the settlement means that no one can ever sue about the merger ever again:
Professor Sean Griffith and Professor Alexandra Lahav argue that merger litigation is merely a way for buyers to obtain releases that accompany any settlement. In exchange, they do not have to worry about new claims popping up from shareholders.
The value to corporations is real. Consider an extensive antitrust litigation going on in Boston, in which plaintiffs’ law firms are asserting that private equity firms colluded in their bidding in several mergers. In that case, the plaintiffs are handicapped since many of the private equity firms obtained these releases in connection with their own buyouts. In other words, the private equity firms have benefited from merger litigation and are using the releases obtained from it against the same plaintiffs’ lawyers who are now suing them.
You don’t have to think that the private equity antitrust lawsuits are right – I basically don’t though a few of the claims are troubling – to think this was a bad trade for shareholders. Imagine that someone actually did unearth a massive LBO price-fixing conspiracy, and then shareholders couldn’t get any damages for it because lawyers they’d never met had signed away all legal claims by anyone in perpetuity in exchange for $600K in those lawyers’ pockets.