Let’s Outlaw Abuses Behind Takeover Bids

One of the best pieces of news about the economy this month was the visit by 16 leading corporate executives to the halls of Congress. Their mission: to ask for legislation curbing abuses by corporate raiders and by Wall Street in the current wave of takeover bids.

Legislation has been badly needed for some time, yet until now the business community has not applied much pressure for it. In fact, most top executives have opposed such proposals, fearing government interference. Wall Street leaders, for their part, have always opposed government regulation and still do. Hence, it will take some effort on the part of the broader business community to get any action.

Congress is ready to listen because of the spreading insider trading scandal in which well-known speculators and figures within major investment banking firms conspired to profit on advance word of takeover negotiations. The scandal, however, only serves to confirm what some people have been warning all along--that the corporate raiding game often involves stock market manipulation.

Too-Easy Credit

As in past periods of unusually rapid advances in stock prices, the current red-hot market reflects some faulty reasoning about what companies are worth. At least some of the current run-up reflects the high prices being paid in takeovers and mergers, activities that tend to ignite interest in stocks generally. Yet the fuel for those high prices is mostly easy credit rather than hard cash.

When values can be distorted so readily, the market becomes a good hunting ground for those seeking quick profit. Some players stay just inside the law. Others succumb to temptation and take the effort beyond legal limits. Obviously, the insider trading conspiracies are a case of the latter. Laws already are in place to punish those individuals. The more difficult problem is those whose activities involve an abuse of the system rather than a clear violation of existing regulations.

The abuse in this case is the ability of corporate raiders, with help from investment banking houses, to borrow huge sums quickly, take a position in a stock and then make a public offer to buy more. The effect of this activity has become clear in recent years. The raiders get into the stock at a relatively low price without having to state publicly their real intention. Then they make an offer to purchase more stock well above the market price.

The immediate result is to bid up the price of the stock and leave the raiders with a paper profit on the shares they already hold. At that point, they have a number of ways to profit. They can make a deal to back off from their attack and sell their block back to the company that they are trying to take over, a tactic that has come to be called greenmail. They can go ahead with the takeover, buying the company almost entirely with borrowed funds. Or, they can sell out to another company that comes in with a competing bid for the takeover target. It is not a sure thing, but recent history shows that the profits have been enormous.

Call It What It Is

So far, most of the proposals for ending such abuses sidestep the real issue. They would give management more power to block a takeover effort--for example, by applying new rules as to how long a tender offer has to remain open and by outlawing greenmail. What they don’t do is put the proper label--manipulation--on the practice--and then outlaw it.

Raiders shouldn’t be permitted to invest first and disclose later. Investment banking firms shouldn’t be permitted to set up the financing for a takeover without disclosing their intention first. And no one should be permitted to buy a publicly owned company without having to pay for it. Margin requirements were invented to halt just such abuses. Tough regulation in this area would knock the stuffing out of a wasteful takeover binge. At the same time, it would force so much public disclosure that the inside traders would find far less on which to profit.

Forget the argument that restricting takeovers will let corporate management entrench itself. Takeover mania has produced weaker companies, not stronger ones. The business community finally is recognizing that.