New Laws Needed to Make Takeover Fights Fair

The battle for control of Union Carbide earlier this year, and more recently for Safeway Stores, are reminders that federal and state laws regulating corporate takeovers are a mess.

These laws do not provide fair or orderly procedures for resolving competing offers to acquire a corporation. Instead, this Rube Goldberg regulatory structure--and its loopholes--allows bidders to defeat their opponents not through the merit of their offers but through legal ingenuity. If the public or stockholders share in such victories, that is only accidental.

The Securities and Exchange Commission on July 8 adopted rules to eliminate some current takeover anomalies. Those changes are inadequate, however, and so is even the broader Tender Offer Reform Act proposed last December by Sens. Alfonse D’Amato (R-N.Y.) and Alan Cranston (D-Calif.).

Neither mega-mergers nor contested takeover battles are going to go away. In fact, the number of these super-deals has grown. Acquisitions valued at $100 million or more have increased steadily--to 268 in 1985 from 15 in 1974.

Most spectacular has been the growth in billion-dollar transactions. Once rare, they have become almost commonplace. There were only four acquisitions valued at more than $1 billion in 1980 but 12 in 1981 and 18 in 1984--and last year the total doubled to 36.

Because so many acquisitions of large public corporations are being undertaken, their outcomes are a matter of national concern.

Congress attempted to address that concern in 1968, when it passed the Williams Act to promote an informed public process that settled takeover questions through a fairly administered auction of shares.

The Williams Act was based on three central ideas: First, a fair market requires that shareholders be given basic information before a takeover attempt; second, buyers will pay a premium price to obtain control of a corporation, and third, all shareholders should have an opportunity to benefit equally.

Three transactions last fall illustrate how far we have strayed from this straightforward approach.

- Unocal used “reverse greenmail” to defeat a takeover bid by T. Boone Pickens Jr. It outbid Pickens and bought up shares from any of its shareholders who were interested in selling--except for Pickens. Thus, we have moved from guaranteeing all shareholders equal opportunity to benefit from takeover bids, to greenmail payments to a single shareholder for ending a takeover bid, to reverse greenmail payments to groups of shareholders not making a takeover bid. The new SEC tender offer rule would forbid only this last transaction.

- Also disconcerting is last year’s federal court decision upholding Hanson Trust’s acquisition of 25% of SCM Corp. at a premium price without following the statutory public tender offer procedures.

The court accepted the argument that the sale was “private” and therefore exempt, but it seems obvious that such exempt sales can destroy the equal participation rights of other shareholders.

- Finally, a Delaware state court upheld the right of Household International to issue “poison pill” securities. As a consequence, corporations can deter unwanted bids by issuing to their shareholders these tiny time capsules of valuable rights that are set to explode whenever a hostile takeover succeeds.

No doubt these legal maneuvers add to the excitement of control battles as a spectator sport. But allowing such strategies does not assure that control will go to the highest bidder; nor do they guarantee shareholders the opportunity to benefit equally. And they make meaningless shareholder rights to information about the takeover.

Until the Supreme Court decided Schreiber vs. Burlington Northern in June, 1985, a few courts had resisted this trend and protected the Williams Act process by invalidating one of the most egregious defensive tactics: They refused to let a target company favor one bidder by entering into a “lockup” agreement. Such agreements give the favored bidder the right to buy some of the target’s assets at a reduced price if the rival bidder gains control of the target.

(There is often a suspicion that one bidder is favored because it offers more generous personal treatment to the target’s managers, either in long-term employment contracts or high severance pay.)

Those courts threw out lockup contracts on the grounds that their effect would be to stop the rival from bidding and thereby cheat the target’s shareholders of their opportunity to receive a higher price in open bidding.

Those lockup rulings were correct, despite the Supreme Court’s conclusion that the Williams Act is only violated when statements result in misleading shareholders.

It should not be lawful to deprive shareholders of an auction-type bidding contest for control of their company. The same principle of fairness would also outlaw most poison pill securities, greenmail, large private sales of securities and two-tier tender offers.

All of these tactics destroy or disrupt the bidding process that was designed to benefit shareholders.

Two-tier tender offers are especially unfair because they give buyers a way to panic shareholders into selling for less than they believe their stock is worth.

Shareholders sell out for this low (first-tier) price because they are fearful the buyer will obtain control of the company and force redemption of any remaining stock at an even lower (second-tier) price.

A piecemeal approach to amending securities laws will not work. What is needed is general authority for the SEC--or the federal courts--to determine the lawfulness of takeover tactics.

To establish a fair and predictable legal framework that will endure, Congress must now guarantee the takeover process whose reform it began with passage of the Williams Act.

The now-dormant D’Amato-Cranston bill would have forbidden only greenmail and large private sales, even though two-tier tender offers, lockups, poison pills and as-yet-undesigned tactics have an equally profound effect on the fairness of takeover transactions.

It is appropriate to forbid these specific abusive takeover practices, but that is not enough. Congress cannot foresee the ingenuity of tomorrow’s takeover tacticians.

Consequently, it should include also a general prohibition that outlaws any takeover tactic that destroys the basis for shareholders making their choice to sell or hold their stock. While some state laws provide a remedy to a few of the abusive takeover tactics, we need a consistent national standard of conduct, particularly because there is more at issue than fairness to shareholders.

If the winning bidder is the person who values the target most highly--rather than the cleverest legal tactician--that ultimate price is more likely to be based on higher estimates of the efficiencies and profits that the acquisition will produce. More efficient businesses benefit all of us as consumers and improve the American economy.

An effective law would make it less likely that buyers would be able to panic shareholders into selling, less likely that corporate managers will be able to prevent serious takeover bids or favor one of competing bidders to further their personal interests, and more likely that the winning bid will be from the highest bidder who will operate the company more efficiently. We can all benefit from that kind of reform.